-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, B6+A1U4cFwMvnGyoBSQzVTOjfCWTol74yECiuwsyA1vaOsRcqXTuBMYXvjR6t4t3 6CFOCC5ZSvnUzxXdnY/HEA== 0000892569-96-000436.txt : 19960430 0000892569-96-000436.hdr.sgml : 19960430 ACCESSION NUMBER: 0000892569-96-000436 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 9 CONFORMED PERIOD OF REPORT: 19960127 FILED AS OF DATE: 19960429 SROS: NONE FILER: COMPANY DATA: COMPANY CONFORMED NAME: CLOTHESTIME INC CENTRAL INDEX KEY: 0000727739 STANDARD INDUSTRIAL CLASSIFICATION: RETAIL-WOMEN'S CLOTHING STORES [5621] IRS NUMBER: 330469138 STATE OF INCORPORATION: DE FISCAL YEAR END: 0131 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: 1934 Act SEC FILE NUMBER: 000-12203 FILM NUMBER: 96551949 BUSINESS ADDRESS: STREET 1: 5325 E HUNTER AVE CITY: ANAHEIM STATE: CA ZIP: 92807 BUSINESS PHONE: 7147795881 MAIL ADDRESS: STREET 1: 5325 E HUNTER AVE CITY: ANAHEIM STATE: CA ZIP: 92807 10-K405 1 FORM 10-K - FISCAL YEAR ENDED; JANUARY 27, 1996 1 ================================================================================ SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K (Mark One) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 [FEE REQUIRED] For the fiscal year ended: January 27, 1996 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED] For the transition period from __________ to __________ Commission File Number: 0-12203 THE CLOTHESTIME, INC. (Exact name of registrant as specified in its charter) Delaware 33-0469138 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 5325 E. Hunter Avenue, Anaheim, California 92807 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (714) 779-5881 Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Common Stock $.001 par value (Title of Class) Rights to Purchase Shares of Common Stock (Title of Class) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No --- --- Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (Section 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ X ] As of April 12, 1996, the aggregate market value of the voting stock held by non-affiliates of the registrant (based on the closing sale price of such stock on such date) was approximately $9,905,302. The number of shares of common stock of the registrant outstanding at April 12, 1996 was 14,198,241 (exclusive of 565,000 treasury shares). DOCUMENTS INCORPORATED BY REFERENCE (1) Portions of the Proxy Statement prepared in connection with the Annual Meeting of Stockholders to be held in 1996 -- Part III. ================================================================================ 2 TABLE OF CONTENTS Page ---- PART I Item 1. BUSINESS............................................... 1 EXECUTIVE OFFICERS OF THE REGISTRANT................... 8 Item 2. PROPERTIES............................................. 10 Item 3. LEGAL PROCEEDINGS...................................... 11 Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS................................................ 13 PART II Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS............................ 14 Item 6. SELECTED FINANCIAL DATA................................ 15 Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.......... 16 Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA............. 24 Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE................. 39 PART III Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT............................................. 39 Item 11. EXECUTIVE COMPENSATION................................. 39 Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT......................................... 39 Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS......... 39 PART IV Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.................................... 40 INDEX TO FINANCIAL STATEMENTS AND SCHEDULES............ 40 SIGNATURES................................................................ 49 i 3 PART I ITEM 1. BUSINESS The Clothestime, Inc., a Delaware corporation ("Clothestime"), and its subsidiaries (collectively, the "Company"), operate a chain of women's apparel stores offering value-priced fashionable sportswear, dresses and accessories. The Company offers a variety of quality brand names found in department and specialty stores and private label merchandise at savings compared with larger, more upscale department and specialty stores. The Company's contemporary merchandise is primarily directed to the fashion-conscious woman who is between 18 to 34 years old, predominantly works full time in a non-professional career, and has a young attitude. The Company also maintains a lesser customer base in the 14 to 17 and 35 and over age groups. CERTAIN DEVELOPMENTS CHAPTER 11 PROCEEDINGS. On December 8, 1995 (the "Petition Date"), Clothestime and five of its subsidiaries, MRJ Industries, Inc. ("MRJ"), Clothestime Stores, Inc. ("Stores"), Clothestime Investment, Inc., Clothestime Acquisition Corporation and Clothestime International, Inc. (collectively, the "Debtors") each commenced a reorganization case by filing a voluntary petition (collectively, the "Petitions") for relief under chapter 11, title 11 of the United States Code (the "Bankruptcy Code") in the United States Bankruptcy Court for the Central District of California, Santa Ana Division (the "Bankruptcy Court"). The cases are being jointly administered by the Bankruptcy Court. Hereinafter, all references to the Company made in connection with any disclosure relating to the Debtors' chapter 11 cases refer solely to the Debtors and exclude Clothestime Insurance Company (Clothestime's captive insurance company subsidiary). The Debtors decided to seek bankruptcy protection after an extensive review of the retail environment and the Debtor's operations. Management of each of the respective companies determined that filing of the Petitions would allow the Debtors the needed time and flexibility to restructure their respective operations. As a result of filing the Petitions, the Company is prohibited from paying any prepetition liabilities and is currently in default under all of its funded debt agreements in effect prior to the Petition Date. As a result, all unpaid principal of, and accrued prepetition interest on, such debt became immediately due and payable. 1 4 Generally, interest on a prepetition debt does not accrue after the commencement of a chapter 11 case. If debts are secured by property with a value that is greater than the amount of the debt, interest may accrue up to the value of the collateral. For financial statement purposes and conservatism only, interest expense on certain secured debt will continue to be accrued but is subject to settlement. No determination has been made regarding the value of the property interests which secure certain debt and, consequently, whether interest thereon will be paid. The Company has ceased accruing interest expense on unsecured debt. Contractual interest (not including interest at default rates) exceeds interest expense recorded in the consolidated statements of operations by approximately $235,000. In accordance with the Bankruptcy Code, the Company can seek Bankruptcy Court approval for the rejection of executory contracts and unexpired leases, including real property leases, which are described below. Any such rejection may give rise to a prepetition unsecured claim for damage. In connection with the Company's chapter 11 cases, there is an ongoing review of all of the Debtors' obligations under its executory contracts, including real property leases. As described below, the Company has already rejected certain real property leases. The Company has initiated preliminary discussions with the official committee of its unsecured creditors that has been appointed pursuant to the Bankruptcy Code concerning the Company's business plan. In addition, the Company has taken actions in the Bankruptcy Court to facilitate the filing of a plan of reorganization, including (i) filing schedules of assets and liabilities and statement of financial affairs with the Bankruptcy Court on January 22, 1996, and filing amendments thereto on March 21, 1996; and (ii) filing a motion with the Bankruptcy Court on April 10, 1996, requesting a bar date of July 15, 1996, for filing proofs of claims against the Company in the chapter 11 cases. Although the Company is unable to predict when it may file a plan or plans of reorganization, the Company has sought and obtained an order of the Bankruptcy Court extending its exclusive period to file and solicit acceptances of a plan of reorganization, pursuant to section 1121 of the Bankruptcy Code, until August 30, 1996, and October 31, 1996, respectively. Pursuant to applicable provisions of the Bankruptcy Code, the Company has the right to seek further extensions of such exclusive periods. The Company expects that it will seek further extensions of such exclusive period; however, the Company is unable to predict at this time whether the Bankruptcy Court would grant any further extensions. See "Item 3. Legal Proceedings," and "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations." The ability of the Company to effect a successful reorganization under chapter 11 of the Bankruptcy Code will depend, in significant part, upon the Company's ability to formulate a reorganization plan that is approved by the Bankruptcy Court and meets the standards for plan confirmation under the Bankruptcy Code. In a chapter 11 reorganization plan, the rights of the Company's creditors and stockholders may be substantially altered. Creditors may realize substantially less than the full face amount of their claim. Equity interests of the Company's stockholders may be diluted or even canceled. Investment in any security of the Company, therefore, should be regarded as highly speculative. It is impossible at this time to predict the actual recovery that different classes of creditors and stockholders might ultimately realize. SIGNIFICANT POSTPETITION EVENTS. Since the Petition Date, the Debtors have continued in possession of their properties and, as debtors in possession, are authorized to operate and manage each of their respective businesses and enter into all transactions (including obtaining services, supplies and inventories) that each could have entered into in the ordinary course of their business had there been no bankruptcy. The Company has sought and obtained orders from the Bankruptcy Court intended to facilitate the normal operations of the Company, including orders (i) authorizing the Company to maintain its consolidated cash management system, (ii) authorizing the payment of certain prepetition claims, including claims for customer returns and for wages, salaries and employee benefits, (iii) approving the Company's debtor in possession financing, which is described below, and (iv) authorizing the closing of certain underperforming stores, as described below. See "Item 3. Legal Proceedings," and "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations." 2 5 On December 28, 1995, the Company, through Stores, entered into, and subsequently the Bankruptcy Court approved, a financing agreement with The CIT Group/Business Credit, Inc. for debtor in possession financing. See "Item 8. Financial Statements and Supplementary Data--Notes to Consolidated Financial Statements; Note C." The Debtors (other than Stores) are guarantors under the agreement. The agreement terminates on the earlier of December 8, 1997 or the effective date of confirmation of the Company's confirmed plan of reorganization, subject to earlier termination. The Company believes that the Bankruptcy Court protection together with its cash resources, revenues generated from operations anticipated expense deduction measures, anticipated tax refunds, and debtor in possession financing will enable it to conduct normal business operations and continue to provide trade creditors with the assurances they need to supply merchandise to the Company. See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations." On December 17, 1995, the Bankruptcy Court authorized the Company to close 137 underperforming stores (including the stores comprising the Company's Lingerie Time division) that were causing a cash drain on the Company's business and weakening the Company operationally. In an effort to maximize the value of the assets at the stores to be closed, the Company also obtained Bankruptcy Court authorization to conduct store closing sales of inventory, equipment, furniture, fixtures and other assets at these locations and to retain a consultant to assist the Company in the process of liquidating its inventory. The store closing sales were completed by January 31, 1996, and at such time one lease was sold at auction and the others were rejected by the Company as of January 31, 1996 pursuant to an order of the Bankruptcy Court or as of February 6, 1996, pursuant to section 365(d)(4) of the Bankruptcy Code. For additional information related to the Company's chapter 11 cases, see "Item 2. Properties" and "Item 3. Legal Proceedings." For additional information on the financial impact of chapter 11 cases on the Company's business, see "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations." OPERATIONS As of January 27, 1996, the Company operated stores in 20 states and Puerto Rico, with a large concentration of stores in California, Florida and Texas. All stores are Company-owned and the majority operate under the "Clothestime" name. The Company added six new stores and closed 183 stores during the fiscal year ended January 27, 1996 ("Fiscal 1995"), ending Fiscal 1995 with 400 stores. The Company has focused, and will continue to focus, on eliminating unproductive stores. See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations." Currently, there are no plans to open any additional stores during the fiscal year ending January 25, 1997 ("Fiscal 1996"). 3 6 The following table illustrates the changes in the number of stores operated by Clothestime during the past five fiscal years:
Stores Stores Stores Stores at Opened Closed at Fiscal Beginning During During End of Year of Year Year Year Year ---- ------- ---- ---- ------ 1991 384 25 8 401 1992 401 73 17 457 1993 457 92 10 539 1994 539 63 25 577 1995 577 6 183 400
All of the stores occupy leased facilities and are located primarily in non-enclosed retail locations in heavily populated urban and suburban areas. The Company employs a strategy of opening stores mainly in convenient, lower-cost real estate locations as compared to major enclosed malls as a means of lowering its cost structure and thereby passing the savings to the customer. To keep pace with current fashion trends, the Company continuously tracks inventory in each of its stores through utilization of a "point-of-sale" terminal system designed to improve tracking of merchandise and sales performance. This system and the related software are regularly upgraded or modified as needs arise or change. The Company's policy is to maintain sufficient quantities of inventory on hand in its retail stores and distribution centers so that it can offer customers a full selection of current merchandise with ample quantities. The use of computer technology at the point of sale facilitates better inventory management by supplying key decision-making information such as sales and price by location, allowing the Company to examine customer preferences and analyze best-selling items on a store-by-store basis. With this data, the Company can take markdowns on a more timely basis or transfer merchandise to an alternative store location where it is likely to move more quickly. This is consistent with the Company's aggressive markdown policy to keep store inventories current and fashionable. In December 1995 and January 1996, in response to price competition, the Company aggressively priced its inventory, depleting the majority of its inventory. For a short period of time, prior to Spring merchandise being delivered to the stores, the Company did not maintain inventory at optimum levels. Sales of merchandise are paid for in cash and by credit cards issued by banks and other financial institutions. The Company does not grant credit or carry its own charge accounts. The Company offers a full money-back guarantee of its merchandise and permits return of merchandise within 30 days after purchase. Cash and credit card refunds are given for merchandise returned with a receipt and exchanges are made for merchandise returned without a receipt. 4 7 Recognizing the important role played by store personnel, all sales associates and store managers are required to complete an education program, which includes training in the areas of merchandising, customer service, loss prevention and display presentation. The Company's business is comprised of two principal selling seasons: Spring (the first and second quarters), which includes the period during which spring and summer styles are introduced; and Fall (the third and fourth quarters), which includes the back-to-school, winter and Christmas selling seasons. Consistent with the majority of clothing retailers, the Company normally posts its strongest sales during the fourth quarter as a result of a stronger Christmas selling period compared to its summer and early Fall selling periods. First quarter sales are generally lower than sales in the other quarters primarily as a result of the high sales activity during the fourth quarter. However, during the past two fiscal years, the Company has realized higher sales levels during the Spring seasons rather than the Fall seasons. Management believes this was primarily due to the highly competitive promotional environment surrounding the holiday seasons as well as the lack of consumer acceptance of merchandise offered. In Fiscal 1996, the Company plans to offer a greater concentration of fashion forward merchandise and novelty items with broader assortments. Management believes that this will improve inventory turnover as well as bring Fall sales back in line with other retailers. As is the case for most clothing retailers, abnormal seasonal weather also may affect sales because the seasonal merchandise then in the stores may not correspond to the merchandise consistent with the abnormal weather. In addition, since most of the Company's stores are located in non-enclosed retail locations as opposed to enclosed malls, the Company's sales can be adversely affected by abnormal rain or other inclement weather. There was no evidence of adverse weather affecting the Company's sales during Fiscal 1995. MERCHANDISING AND MARKETING The Company's merchandise ranges from designer fashion and better sportswear to moderate apparel. The Company maintains a private label program to provide better quality fashionable merchandise that offers significant savings to the budget conscious consumer. In addition, the Company offers, on a more limited basis, quality brand name merchandise, with an emphasis on everyday low prices. Currently, approximately 75% of the Company's apparel merchandise is private label, designed and manufactured to the Company's strict specifications. In Fiscal 1996, the Company intends to offer more novel and "fashion-forward" merchandise and broader assortments than in prior years. In addition, it is the Company's intent to alter the merchandise mix by featuring a greater percentage of novelty items than were featured in Fiscal 1995. In connection with its restructuring efforts, the Company also plans to improve its foreign and basic private label merchandise programs by overseeing the entire production process from start to finish. The Company has a chain-wide, uniform merchandising concept for its "Clothestime" stores. Management believes that this uniform merchandising concept promotes a consistent and comfortable shopping environment. All newly-constructed and remodeled stores conform 5 8 to the Company's standards for design and convenience. In connection with the Company's restructuring efforts, the Company eliminated its Lingerie Time division and closed its nine Lingerie Time stores in Fiscal 1995. The Company's advertising and marketing program is designed to reach women between the ages of 18 and 34. Regional television, radio and direct mail were the principal forms of media that the Company used in Fiscal 1995 for its advertising programs. In connection with the introduction of its Spring merchandise in Fiscal 1996 and its restructuring efforts, the Company has launched a sensationalized, controversial and aggressive marketing campaign, focused primarily towards television, radio and print media spots, designed to rebuild customer traffic and to promote and reinforce that Clothestime is a "cool" place to shop. PURCHASING AND DISTRIBUTION The Company purchases most of its merchandise directly from manufacturers who also sell to department stores, specialty stores, retail chain stores, factory-outlet stores, mass merchandisers and catalogue merchandisers. During Fiscal 1995, the Company purchased from approximately 600 vendors, with no one vendor accounting for 10% or more of the Company's purchases. Management believes that the loss of any one vendor would not have a material adverse effect on the Company. The Company does not maintain any long-term or exclusive commitments or arrangements to purchase from any one vendor. The Company believes that it will be able to continue to purchase merchandise from such vendors or from other vendors supplying similar merchandise. In addition, in Fiscal 1996 the Company intends to explore partnering opportunities relating to product development with certain of its key vendors. Unlike many clothing retailers which make large inventory purchases substantially prior to a fashion season, the Company's inventory purchase pattern corresponds closer in time to, or occurs during, the fashion season. The Company's cash from operations and available credit facilities allow management the flexibility to take advantage of opportunities to effect volume purchases during these periods and the Company's distribution capabilities allow such merchandise to be in the stores quickly. Currently, the majority of merchandise is shipped directly from vendors to the Company's central distribution facility located in Anaheim, California. The Company's utilization of a computer control system to track inventory and monitor distribution plays a key role in inventory control and merchandise distribution. To stabilize vendor relations and address significant vendor claims issues arising in the early stages of their chapter 11 cases, the Company: (i) developed and obtained Bankruptcy Court approval of a "return to vendor" program; and (ii) analyzed the multitude of reclamation notices served by vendors during the initial days following the Petition Date and, on that basis, developed a program which was approved by the Bankruptcy on March 28, 1996 for the reconciliation and eventual payment of reclamation claims. 6 9 TRADEMARKS AND SERVICE MARKS The Company is the owner of the federally registered trademarks "Clothestime," "Best World Brand," "CTME," "Spoiled Girls," "Star Cody," "Via Max" and the federally registered service marks "Clothestime," "Lingerie Time," "Trend Club" and "Always in Fashion. Never Full Price." The expiration dates for the initial registration for these marks range from July 2003 to May 2009. In addition, the Company has registered the trademarks "Clothestime" and "Lingerie Time" in Mexico, such initial Mexican registrations to expire in July 2004. The Company believes these marks are important to its business. The Company intends to maintain the marks and related registrations it currently uses in its business. EMPLOYEE RELATIONS In connection with the Company's restructuring efforts and the closure of a significant number of unproductive stores, the Company eliminated over 1,000 jobs during Fiscal 1995, including a reduction of approximately 24% of the Company's corporate staff. As of January 27, 1996, the Company had 2,744 employees, 1,403 of whom were part-time. A number of additional temporary employees are usually added during peak selling periods. The Company developed and the Bankruptcy Court approved, a key employee retention incentive program to ensure that employees who are crucial to the Company's restructuring efforts will have adequate incentives to remain employed by the Company for the foreseeable future. None of the Company's employees are covered by a collective bargaining agreement. The Company considers its employee relations to be good. COMPETITION The women's retail apparel business is highly competitive. The Company's stores compete with regional and national department store chains, mass merchandiser stores, independent retail stores, factory-outlet stores and numerous national and regional catalogue merchandisers. Many of its competitors are considerably larger than the Company and have substantially greater financial and other resources. Clothestime competes primarily on the basis of fashion, price, selection and style, merchandise display and store location and design. The Company believes that its strategy of offering a mix of brand name and private label merchandise to the junior-sized customer at savings compared with department and specialty stores and its ability to effect volume purchases are important elements in its operations. 7 10 EXECUTIVE OFFICERS OF THE REGISTRANT The executive officers of Clothestime are as follows:
YEAR COMMENCED SERVICE WITH NAME AGE THE COMPANY POSITION ---- --- ----------- -------- John Ortega II 47 1978 Chief Executive Officer and Chairman of the Board Norman Abramson 56 1986 President and Chief Operating Officer David A. Sejpal 38 1986 Vice President, Chief Financial Officer, Treasurer and Secretary Jeffrey R. Dake 47 1984 Vice President - Real Estate and Construction Charles Castaneda 41 1994 Vice President - Merchandise Planning and Control
Executive officers are elected annually and serve at the pleasure of the Board of Directors. JOHN ORTEGA II is one of the founders of the Company and has served as Chairman of the Board since September 1990. In addition, Mr. Ortega serves as a director and Chairman of the Board, a director and officer position, of MRJ, the distribution, purchasing and management services subsidiary of the Company, and as a director and Chairman of the Board and Chief Executive Officer of the Stores, the subsidiary of the Company which conducts its retail operations, positions he has held since December 1993. In addition, Mr. Ortega was elected Chief Executive Officer of the Company and MRJ in January 1995. Mr. Ortega served as Vice Chairman of the Board of the Company from September 1982 to September 1990 and as Vice President of the Company from the Company's inception to September 1982. Mr. Ortega is also a director of the Company, a position which he has held since 1978. 8 11 NORMAN ABRAMSON has served as President and Chief Operating Officer of the Company since February 1987. In addition, Mr. Abramson serves as a director and President, Chief Operating Officer and Secretary of both MRJ and Stores, positions he has held since December 1993. Mr. Abramson also served as Executive Vice President and Chief Operating Officer of the Company between April 1986 and February 1987 and Secretary of the Company from March 1991 to April 1995. Mr. Abramson is also a director of the Company, a position which he has held since 1986. DAVID A. SEJPAL has served as a Vice President of the Company since June 1991, its Chief Financial Officer since December 1990, its Treasurer since May 1991 and Secretary since April 1995. In addition, Mr. Sejpal serves as Vice President, Chief Financial Officer, Treasurer and Assistant Secretary of MRJ, positions he has held since December 1993. Mr. Sejpal served as Corporate Controller of the Company from September 1988 to December 1990 and Director of Finance from December 1986 to September 1988. Mr. Sejpal also is a director of the Company, a position which he has held since April 1995. JEFFREY R. DAKE has been Vice President - Real Estate and Construction since joining the Company in June 1984. In addition, Mr. Dake serves as Vice President - Real Estate and Construction of MRJ, a position which he has held since December 1993. CHARLES CASTANEDA has served as Vice President - Merchandise Planning and Control of the Company since September 1995, and Senior Director of Planning and Control of the Company from August 1994 to September 1995. Prior to joining the Company, Mr. Castaneda was employed by Saks Fifth Avenue from October 1989 to August 1994, most recently serving as Director, Corporate Planning and Merchandise Control. There are no arrangements or understandings pursuant to which any of the persons listed in the table above were selected as executive officers. 9 12 ITEM 2. PROPERTIES The Company's principal executive offices and distribution facility are located on a five-acre tract in Anaheim, California, in a building designed specifically for the Company, consisting of approximately 27,000 feet of two-story office space and approximately 82,400 square feet of distribution/warehouse space (the "Headquarters' Facility"). The Company occupies the Headquarters' Facility under a triple net lease with an affiliated partnership (the "Partnership") which expires in November 1998 (the "Headquarters' Lease"). See "Item 13. Certain Relationships and Related Transactions." Stores owns an office and warehouse facility located on the same block as the Headquarters' Facility. It consists of approximately 25,700 square feet of two-story office space and approximately 24,600 square feet of warehouse space. This office and warehouse building is security for a $1.4 million loan agreement between Stores and Wells Fargo Bank and a $40 million credit agreement between Stores, on the one hand and Wells Fargo Bank and Union Bank, on the other hand. The loan agreement and the credit facility are both guaranteed by the Company and certain other of the Company's subsidiaries. During Fiscal 1995, the Company leased another warehouse facility in Anaheim, California from a non-affiliated party. That facility, which is across the street from the Headquarters' Facility, consists of 22,389 square feet and was primarily used for warehouse and storage space. This lease was rejected as of February 15, 1996 pursuant to section 365(d)(4) of the Bankruptcy Code. The Company leases all its retail stores. Store leases generally have an initial term of one to 20 years and will expire at various dates through 2007. Some leases contain renewal options for periods ranging from one to ten years on substantially the same terms and conditions as the initial leases. The following table sets forth information concerning lease expirations with respect to leases in effect as of the end of Fiscal 1995 (January 27, 1996), excluding those leases for stores that were closed after commencement of the chapter 11 cases or leases that were either sold in the lease auction conducted on January 31, 1996 or were rejected by the Debtors as of January 31, 1996 or February 6, 1996 (see "Item 1. Business--Certain Developments; Significant Post-Petition Events"):
Number of Leases Number of Leases Expiring Calendar Years Expiring with Renewal Options ------------------------------------------------------------------ 1996-1997 110 103 1998-1999 58 46 2000-2001 93 79 2002-2003 101 96 2004-2005 35 33 2006-2007 2 0 Month to Month 1 0 Total 400 357
10 13 Under most of the store leases, the Company is required to pay taxes, insurance and its pro rata share of common area and maintenance expenses. Most of these leases also require the Company to pay the greater of a specified minimum rent or a contingent rent based on a percentage of gross sales. In addition, many store leases include cancellation clauses exercisable by the Company upon the occurrence of certain events (e.g., change in the anchor tenant or a failure to reach certain minimum sales levels). See "Item 8. Financial Statements and Supplementary Data--Notes to Consolidated Financial Statements; Note J." Under section 365(d)(4) of the Bankruptcy Code, unless otherwise ordered by a bankruptcy court, a chapter 11 debtor must assume all leases of non-residential real property within 60 days of its chapter 11 filing or such leases will be deemed rejected. By order of the Bankruptcy Court effective as of February 5, 1996, the Company obtained an extension of time within which to assume or reject its non-residential real property leases through and including the confirmation date of its plan of reorganization, except for certain leases of non-residential real property between the Company and certain objecting landlords for which the time within which such leases must be assumed or rejected was extended to September 30, 1996. Consistent with its responsibility to its creditors, the Company intends to continue to evaluate on an ongoing basis the terms of its non-residential real estate leases to determine whether to take any further actions with respect to the leases, including assuming or rejecting leases in the chapter 11 proceedings, terminating leases, allowing leases to expire, renegotiating existing leases and entering into new leases. The Company is continuing to focus on eliminating unproductive stores. See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations." In connection with such ongoing evaluations, since the commencement of the Company' chapter 11 cases, the Company has rejected 142 retail store leases. As of March 29, 1996, the Company was operating 397 retail stores. In management's opinion, the Company's current administrative offices and warehouse and distribution facilities are adequate for its current level of operations as well as the Company's anticipated level of operations through the end of the fiscal year ending January 25, 1997. ITEM 3. LEGAL PROCEEDINGS On December 8, 1995, Clothestime and five of its subsidiaries, Clothestime Stores, Inc., MRJ Industries, Inc., Clothestime Acquisition Corporation, Clothestime Investment, Inc. and Clothestime International, Inc., filed petitions in the United States Bankruptcy Court for the Central District of California, Santa Ana Division, Jointly Administered Case No. SA95-22533JW, seeking reorganization under chapter 11 of the Bankruptcy Code. The following discussion provides general background information regarding the chapter 11 cases, but is not intended to be an exhaustive summary. Since the Petition Date, the Debtors have continued in possession of their properties and, as debtors in possession, are authorized to operate and manage their respective businesses and enter into all transactions (including obtaining services, supplies and inventories) that each could have entered into in the ordinary course of their business had there been no bankruptcy. 11 14 Although each Debtor is authorized to operate its business as a debtor in possession, it may not engage in transactions outside the ordinary course of business without first complying with the notice and hearing provisions of the Bankruptcy Code and obtaining Bankruptcy Court approval where necessary. On December 15, 1995, an official unsecured creditors' committee (the "Creditors' Committee") was appointed by the Office of the United States Trustee pursuant to section 1102 of the Bankruptcy Code. The Creditors' Committee has the right to review and object to certain business transactions and is expected to participate in the negotiation of any plan of reorganization. The Company is required to pay certain expenses of the Creditors' Committee, including counsel fees, to the extent allowed by the Bankruptcy Court. As debtors-in-possession, the Debtors have the right, subject to the approval of the Bankruptcy Court, under relevant provisions of the Bankruptcy Code, to assume or reject executory contracts and unexpired leases, including real property leases. Certain parties to such executory contracts and unexpired leases with the Company, including parties to such real property leases, may file motions with the Bankruptcy Court seeking to require the Company to assume or reject those contracts or leases. In this context, "assumption" requires that the Company cure, or provide adequate assurance that it will cure, all existing defaults under the contract or lease and provide adequate assurance of future performance under relevant provisions of the Bankruptcy Code: and "rejection" means that the Company is relieved from its obligations to perform further under the contract or lease. Rejection of an executory contract or lease may constitute a breach of that contract and may afford the non-debtor party the right to assert a claim against the bankruptcy estate for damages arising out of the breach, which claim shall be allowed or disallowed as if such claim had arisen before the date of the filing of the petition. By order of the Bankruptcy Court, effective February 5, 1996, the Company obtained an extension of time within which to assume or reject its non-residential real property leases through and including the confirmation date of its plan of reorganization, except for certain leases of non-residential real property and certain objecting landlords for which the time within which such leases must be assumed or rejected was extended to September 30, 1996. Since the Petition Date and as of March 29, 1996, the Company had rejected 142 retail store leases. See "Item 2. Properties." Prepetition claims that were contingent, unliquidated, or disputed as of the commencement of the Company's chapter 11 cases, including, without limitation, those that arise in connection with rejection of executory contracts or unexpired leases, may be allowed or disallowed depending on the nature of the claim. Such claims may be fixed by the Bankruptcy Court or otherwise settled or agreed upon by the parties and approved by the Bankruptcy Court. As a general matter, the treatment of claims pending in the Bankruptcy Court will be determined as part of the formulation and confirmation of a plan of reorganization. Described below are two adversary proceedings now pending in the Bankruptcy Court. On January 24, 1996, Wells Fargo Bank, N.A., individually and as agent for itself and Union Bank (collectively, "Wells"), commenced an adversary proceeding in the Bankruptcy Court, Adversary Proceeding No. 96-1100, against the Debtors claiming that a tax refund, estimated to be approximately $9.3 million (the "Tax Refund"), which the Company anticipates receiving in respect of Fiscal 1995, is subject to Wells' prepetition lien on certain of the 12 15 Company's assets. Wells also requested the entry of a Temporary Restraining Order ("TRO") directing the Company to segregate the proceeds of the Tax Refund (which are not expected to be received prior to May 1996) pending a trial and entry of a judgment in this adversary proceeding. The Company disputes Wells' claims. The parties to the adversary proceeding entered into a stipulation settling Wells' request for the TRO and setting a briefing and discovery schedule in the adversary proceeding. The trial is presently scheduled for June 3, 1996. On January 5, 1996, the Company commenced an adversary proceeding in the Bankruptcy Court against Wells, Adversary Proceeding No. 96-01017. Wells asserts that it has a lien on certain credit card receivables and in a deposit account estimated to be in the aggregate amount of approximately $2.5 million. The Company instituted this proceeding to obtain a judicial determination and declaration that Wells does not hold a valid and perfected security interest in the credit card receivables or the deposit account or, alternatively, that the security interest, if any, held by Wells in such property can be avoided. To the best of management's knowledge, there are no other material pending legal proceedings. The Company is, however, subject to other legal proceedings and claims which have arisen in the ordinary course of its business. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS Not applicable. 13 16 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The common stock of the Company is listed on the National Association of Securities Dealers Automated Quotation System ("NASDAQ") and designated a NASDAQ/National Market System security, trading under the symbol CTMEQ. The table sets forth the range of high and low bid information for the periods and the date indicated as reported by NASDAQ. These quotations reflect interdealer prices, without retail mark-up, mark-down or commission and may not necessarily represent actual transactions. The number of shareholders of record as of April 12, 1996 was 649. STOCK PRICE SUMMARY
High Bid Low Bid - ---------------------------------------------------------- Year ended January 28, 1995: - ---------------------------------------------------------- 1st Quarter $8 3/8 $5 7/8 2nd Quarter 6 1/4 4 1/16 3rd Quarter 5 3 5/8 4th Quarter 4 1/8 2 7/8 - ---------------------------------------------------------- Year ended January 27, 1996: - ---------------------------------------------------------- 1st Quarter $3 7/8 $2 1/2 2nd Quarter 3 1/8 2 11/16 3rd Quarter 3 3/4 2 1/2 4th Quarter 2 5/8 3/8 - ---------------------------------------------------------- At April 12, 1996 $ 13/16 $ 3/4 - ----------------------------------------------------------
The Company has never paid cash dividends on its common stock following a philosophy of retaining earnings in order to finance the expansion and development of its business. Currently, the Company is prohibited from making cash dividend payments under its debtor in possession financing. See "Item 8. Financial Statements and Supplementary Data--Notes to Consolidated Financial Statements; Note C." Also see the discussion under the caption "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations-Liquidity and Capital Resources." 14 17 ITEM 6. SELECTED FINANCIAL DATA - -------------------------------------------------------------------------------- SELECTED FINANCIAL DATA The following table summarizes selected financial data for the Company and should be read in connection with the Consolidated Financial Statements, related notes and other financial information appearing elsewhere in this report.
Year Ended - --------------------------------------------------------------------------------------------------------- January 27, 1996 January 28, 1995 January 29, 1994 (52 Weeks) (52 Weeks) (52 Weeks) ----------------------------------------------------- In thousands, except per share amounts (Fiscal 1995) (Fiscal 1994) (Fiscal 1993) - --------------------------------------------------------------------------------------------------------- CONSOLIDATED STATEMENT OF EARNINGS DATA Net sales, interest and other income $ 308,810 $ 342,280 $ 349,482 Cost of sales, including buying and distribution and occupancy costs 236,872 245,543 237,766 Selling, general and administrative expenses 101,107 110,566 95,307 Loss on disposal of property, plant and equipment - 3,378 1,739 Asset write down - - - Interest expense 769 856 71 Other expenses (income) 1,103 411 91 - ----------------------------------------------------------------------------------------------------- Total costs and expenses 339,851 360,754 334,974 - ----------------------------------------------------------------------------------------------------- Income (loss) before reorganization costs and income taxes (31,041) (18,474) 14,508 Reorganization costs 21,967 - - Income (loss) before income taxes (53,008) (18,474) 14,508 Provision (benefit) for income taxes (10,006) (7,233) 6,340 - ----------------------------------------------------------------------------------------------------- Net income (loss) $ (43,002) $ (11,241) $ 8,168 - ----------------------------------------------------------------------------------------------------- Earnings (loss) per share $ (3.03) $ (0.79) $ 0.56 Weighted average number of common and common equivalent shares outstanding during the year 14,190 14,161 14,660 - ----------------------------------------------------------------------------------------------------- CONSOLIDATED BALANCE SHEET DATA Cash and cash equivalents $ 34,478 $ 40,830 $ 2,706 Working capital 32,671 40,597 21,351 Total assets 88,280 140,402 115,455 Long-term debt, excluding current portion - 37,234 2,823 Shareholders' equity 8,311 50,914 62,466 - -----------------------------------------------------------------------------------------------------
Year Ended - --------------------------------------------------------------------------------------- January 30, 1993 January 25, 1992 (53 Weeks) (52 Weeks) ----------------------------------- In thousands, except per share amounts (Fiscal 1992) (Fiscal 1991) - --------------------------------------------------------------------------------------- CONSOLIDATED STATEMENT OF EARNINGS DATA Net sales, interest and other income $ 317,122 $ 260,231 Cost of sales, including buying and distribution and occupancy costs 213,147 174,567 Selling, general and administrative expenses 84,402 74,065 Loss on disposal of property, plant and equipment 3,110 1,105 Asset write down 1,468 - Interest expense - 548 Other expenses (income) (506) (88) - ------------------------------------------------------------------------------------ Total costs and expenses 301,621 250,197 - ------------------------------------------------------------------------------------ Income (loss) before reorganization costs and income taxes 15,501 10,034 Reorganization costs - - Income (loss) before income taxes 15,501 10,034 Provision (benefit) for income taxes 6,848 4,565 - ------------------------------------------------------------------------------------ Net income (loss) $ 8,653 $ 5,469 - ------------------------------------------------------------------------------------ Earnings (loss) per share $ 0.58 $ 0.37 Weighted average number of common and common equivalent shares outstanding during the year 14,958 14,941 - ------------------------------------------------------------------------------------ CONSOLIDATED BALANCE SHEET DATA Cash and cash equivalents $ 16,928 $ 13,955 Working capital 20,931 21,612 Total assets 100,838 86,705 Long-term debt, excluding current portion - - Shareholders' equity 54,210 49,674 - ------------------------------------------------------------------------------------
15 18 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - -------------------------------------------------------------------------------- CHAPTER 11 REORGANIZATION On December 8, 1995, the Company and five of its subsidiaries commenced reorganization cases by filing voluntary petitions for relief under chapter 11, title 11 of the United States Code in the United States Bankruptcy Court for the Central District of California, Santa Ana Division. See "Liquidity and Capital Resources" below. The Company decided to seek bankruptcy protection after an extensive review of the current retail environment and the Company's operations. Management determined that filing the chapter 11 petitions would allow the Company the needed time and flexibility to restructure its operations. - -------------------------------------------------------------------------------- CONSOLIDATED RESULTS OF OPERATIONS The consolidated financial statements have been presented on the basis that the Company is a going concern, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. As a result of the chapter 11 filing and circumstances relating to this event, realization of assets and satisfaction of liabilities is subject to uncertainty. A plan of reorganization could materially change the amounts reported in the accompanying consolidated financial statements, which do not give effect to all adjustments to the carrying values of assets and liabilities which may be necessary as a consequence of the confirmation and implementation of a plan of reorganization. The ability of the Company to continue as a going concern is dependent on, among other things, confirmation of an acceptable plan of reorganization, future profitable operations, compliance with the debtor in possession financing agreement and the ability to generate sufficient cash from operations and obtain financing sources to meet future obligations. The following table sets forth certain items in the Consolidated Statements of Operations expressed in percentage relationship to total revenues and as compared to the prior periods.
Percentage Point Variance Fiscal Year Ended For Fiscal Years ------------------------------------------- ------------------ January 27, January 28, January 29, 1995 1994 1996 1995 1994 to to (52 Weeks) (52 Weeks) (52 Weeks) 1994 1993 ------------------------------------------------------------------- (Fiscal 1995) (Fiscal 1994) (Fiscal 1993) - ---------------------------------------------------------------------------------------------------------- Total revenues 100.0% 100.0% 100.0% 0.0% 0.0% Cost of sales, including buying and distribution and occupancy costs 76.7 71.7 68.1 (5.0) (3.6) Selling, general and administrative expenses 32.7 32.3 27.3 (0.4) (5.0) Loss on disposal of property, plant and equipment - 1.0 0.5 1.0 (0.5) Interest expense 0.3 0.3 - - (0.3) Other expenses 0.4 0.1 - (0.3) (0.1) Income (loss) before reorganization costs and income taxes (10.1) (5.4) 4.1 (4.7) (9.5) Reorganization costs 7.1 - - (7.1) - Income (loss) before income taxes (17.2) (5.4) 4.1 (11.8) (9.5) Provision (benefit) for income taxes (3.2) (2.1) 1.8 (1.1) (3.9) - -------------------------------------------------------------------------------------------------------- Net income (loss) (14.0%) (3.3%) 2.3% (10.7%) (5.6%) ========================================================================================================
16 19 - -------------------------------------------------------------------------------- NET SALES Net sales decreased 9.6% in Fiscal 1995 after having decreased 1.9% in Fiscal 1994 and increasing 10.3% in Fiscal 1993. Comparable store sales (stores in operation for at least 15 months) decreased 6.1% in Fiscal 1995 compared to Fiscal 1994. Clothestime ended Fiscal 1995 with 177 fewer stores than at the end of Fiscal 1994, which contributed to the overall decline in sales. In addition, management believes that the continued weakness in the women's apparel specialty retail segments in general, and the soft California markets in particular, combined with increased competition from department stores, mass-merchandisers and discount retailers were principal factors which negatively affected sales. In Fiscal 1995, the Company increased its offering of basic merchandise and carried less novel and fashion forward merchandise. This resulted in the Company being forced to compete on price and not being able to differentiate itself from the mass merchandisers and department stores. The quarterly sales performance in Fiscal 1995 versus the comparable periods of Fiscal 1994 decreased 13.4%, 4.5%, 2.1%, and 18.7% in the first, second, third and fourth quarters, respectively. The decrease in fourth quarter sales for Fiscal 1995 is the result of the Company filing chapter 11 on December 8, 1995 causing a sharp decrease of merchandise shipments and a general uncertainty amongst our customers as to our continuing operations. For the same periods of Fiscal 1995 compared to Fiscal 1994, comparable stores sales decreased 17.4% and 5.2% in the first and second quarters, respectively, increased 2.0% in the third quarter and decreased 2.9% in the fourth quarter. Comparable store sales results benefited in the fourth quarter of Fiscal 1995 from aggressive discounts taken chain-wide to compete in the highly promotional environment. Comparable store sales results for the fourth quarter are better than total sales results due to the closing of 137 underperforming stores early in the fourth quarter. Net sales decreased 1.9% in Fiscal 1994 after having increased by 10.3% in Fiscal 1993. Comparable store sales decreased by 13.1% in Fiscal 1994 compared to Fiscal 1993. Management believes that the continued weakness in the women's apparel specialty retail segments and less consumer acceptance of the merchandise offered by the Company were the principal factors which negatively affected sales in Fiscal 1994. The quarterly sales performance in Fiscal 1994 versus the comparable periods of the prior fiscal year increased in the first and second quarters, 6.6% and 0.9%, respectively, and decreased in the third and fourth quarters, 1.4% and 12.2%, respectively. For the same periods, comparable store sales decreased 8.7%, 12.0%, 13.2% and 18.0% in the first, second, third and fourth quarters, respectively. Management believes that the continuing weakness in the women's apparel specialty retail segments and the increasing competition for market share were the primary factors affecting fourth quarter sales results for Fiscal 1994. The Company's primary target market is women in the 18 to 34 age group. While customer demographics revealed that this age range represents a significant portion of our customers, the Company still maintains a lesser customer base in the 14 to 17 and 35 and over age groups. During Fiscal 1995, the Company attempted to raise the average age of its customers by offering an improved quality merchandise mix aimed towards a young, career minded woman. This strategy, while successful at raising quality standards, did not attract the career customer and did not satisfy our existing, fashion-minded customer base. 17 20 The Company's business is comprised of two principal selling seasons: Spring (the first and second quarters) which includes the period during which spring and summer styles are introduced; and, Fall (the third and fourth quarters) which includes the back-to-school, winter and Christmas selling seasons. Consistent with the majority of clothing retailers, the Company normally posts its strongest sales during the fourth quarter as a result of a stronger Christmas selling period compared to its summer and early Fall selling periods. First quarter sales are generally lower than sales in the other quarters primarily as a result of the high sales activity during the fourth quarter. However, during the past two fiscal years, the Company has realized higher sales levels during the Spring seasons rather than the Fall seasons. Management believes this was primarily due to the highly competitive promotional environment surrounding the holiday seasons as well as the lack of consumer acceptance of merchandise offered. In Fiscal 1996, the Company intends to offer more novel and "fashion-forward" merchandise and broader assortments than in prior years. In addition, it is the Company's intent to alter the merchandise mix by featuring a greater percentage of novelty items than were featured in Fiscal 1995. Management believes that this will improve inventory turnover as well as bring Fall sales back in line with other retailers. As is the case for most clothing retailers, abnormal seasonal weather may also affect sales because the seasonal merchandise then in the stores may not correspond to the merchandise consistent with the abnormal weather. In addition, since most of the Company's stores are located in non-enclosed retail locations as opposed to enclosed malls, the Company's sales can be adversely affected by abnormal rain or other inclement weather. There was no evidence of adverse weather affecting sales during Fiscal 1995. - -------------------------------------------------------------------------------- INTEREST AND OTHER INCOME; INTEREST EXPENSE; OTHER EXPENSES Interest and other income as a percentage of net sales decreased to 0.2% in Fiscal 1995 from 0.4% in Fiscal 1994 as a result of a lower invested cash balance. Interest and other income as a percentage of net sales decreased to 0.4% in Fiscal 1994 from 0.5% in Fiscal 1993. Lower interest rates due to the shortening of the Company's investment portfolio's duration and a lower invested cash balance stemming from the decrease in net sales were the primary factors leading to the decrease in interest and other income in Fiscal 1994. Interest expense was $769 thousand in Fiscal 1995, compared to $856 thousand in Fiscal 1994 and $71 thousand in Fiscal 1993. The decrease in interest expense in Fiscal 1995 is due to approximately $235 thousand of contractual interest expense not being recorded as a result of the chapter 11 filing. The interest expense stemmed from outstanding borrowings under the Company's revolving credit facility, additional borrowings of $1.4 million made during the first quarter of Fiscal 1995, bank loans of $1.9 million taken out in the fourth quarter of Fiscal 1993, and a capital lease obligation of $1.9 million entered into during Fiscal 1993. (See Note D to Consolidated Financial Statements). Other expenses in Fiscal 1995 of $1.1 million are made up of $405 thousand of capital losses from the sale of marketable securities and $706 thousand to write down investments. Other expenses in Fiscal 1994 and Fiscal 1993 of $411 thousand and $90 thousand, respectively, were due to capital losses from the sale of marketable securities. 18 21 - -------------------------------------------------------------------------------- COST OF SALES Cost of sales as a percentage of total revenues increased to 76.7% in Fiscal 1995 from 71.7% in Fiscal 1994 and 68.1% in Fiscal 1993. The increase in cost of sales as a percentage of total revenues in Fiscal 1995 compared to Fiscal 1994 was primarily due to customer resistance to product and pricing and a fiercely competitive retail environment resulting in significant markdown activity. Cost of sales as a percentage of total revenues in Fiscal 1994 compared to Fiscal 1993 rose as a result of increases in markdowns required to sell merchandise in the highly promotional retail environment and higher occupancy costs. Cost of sales as a percentage of total revenues increased to 89.2% in the fourth quarter of Fiscal 1995 compared to 76.1% and 69.7% for the same period in Fiscal 1994 and Fiscal 1993. The increase in cost of sales as a percentage of total revenues for the fourth quarter of Fiscal 1995 compared to the same period of Fiscal 1994 was the result of aggressive markdowns taken to clear out the Fall merchandise by the end of the holiday selling season. Cost of sales as a percentage of total revenues increased for the fourth quarter of Fiscal 1994, compared to the same period of Fiscal 1993, due to increased markdowns. - -------------------------------------------------------------------------------- SELLING, GENERAL AND ADMINISTRATIVE EXPENSES Selling, general and administrative expenses were $101.1 million in Fiscal 1995 compared to $110.6 million in Fiscal 1994 and $95.3 million in Fiscal 1993. The decrease of $9.5 million in selling, general and administrative expenses in Fiscal 1995 compared to Fiscal 1994 was principally attributable to a net reduction of 177 stores, primarily occurring in the fourth quarter, and various cost cutting measures implemented at the corporate office. Selling, general and administrative expenses as a percentage of total revenues increased to 32.7% in Fiscal 1995 compared to 32.3% in Fiscal 1994 and 27.3% in Fiscal 1993. The increase in selling, general and administrative expenses as a percentage of revenues in Fiscal 1995 compared to Fiscal 1994 was primarily due to an increase in store operating and supervisory payroll costs to support sales levels which were not realized, partially offset by a decrease in advertising costs due to the elimination of television advertising. The increase in selling, general and administrative expenses as a percentage of total revenues in Fiscal 1994 compared to Fiscal 1993 was primarily due to increases in advertising costs, store operating and supervisory payroll, other expenses attributable to store operations and administration and store maintenance costs. The following table sets forth the amount of percentage point variance as a percentage of total revenues and the difference in dollar expense relating to the increase in selling, general and administrative expenses attributable to the factors discussed above for the periods indicated.
Fiscal 1995 to Fiscal 1994 Fiscal 1994 to Fiscal 1993 -------------------------- -------------------------- Dollars in thousands Percent Amount Percent Amount - -------------------------------------------------------------------------------------------------- Store operating and supervisory payroll 0.6% $(2,649) 1.5% $ 4,216 Advertising costs (0.2) (2,143) 1.1 3,676 Other expenses attributable to store operations and administration 0.2 (3,269) 1.9 5,828 Store maintenance costs (0.2) (1,397) 0.5 1,538 - -------------------------------------------------------------------------------------------------- 0.4% $(9,458) 5.0% $15,258
During Fiscal 1995, the Company utilized the $2.0 million accrual for store closures it had recorded at the end of Fiscal 1994. During Fiscal 1994 and Fiscal 1993, the Company expensed $3.4 million and $1.7 million, respectively, primarily for store closings and remodels. See "Reorganization Costs" below and Note E to the Consolidated Financial Statements, for costs incurred with the closing of 137 stores under Bankruptcy Court approval and other costs. 19 22 - -------------------------------------------------------------------------------- REORGANIZATION COSTS The Company recorded $22.0 million for costs associated with the chapter 11 filing. Included are approximately $19.9 million for costs and expenses associated with the closing of 137 unprofitable stores (including estimated lease rejection claims), and approximately $1.7 million for legal, accounting and other professional fees. The Company anticipates that it will incur additional reorganization costs throughout its chapter 11 reorganization. The reorganization costs are more fully described in Note E to the Consolidated Financial Statements. - -------------------------------------------------------------------------------- PROVISION (BENEFIT) FOR INCOME TAXES The Company recorded a tax benefit of $10.0 million in Fiscal 1995. The loss in Fiscal 1995 will enable the Company to recover all remaining prior years' taxes within the three-year carryback period. The Company's effective income tax benefit rate was 18.9% for fiscal 1995. This rate was less than the Federal tax rate primarily due to limitations on the amount of taxes available to recover from prior years' and the recognition of a valuation allowance to fully offset the net deferred tax asset. The Company's effective tax rate decreased to 39.2% in Fiscal 1994 from 43.7% in Fiscal 1993. The decrease in Fiscal 1994 resulted primarily from the effect of nontaxable revenues. Income taxes (benefit) are more fully described in Note G to the Consolidated Financial Statements. - -------------------------------------------------------------------------------- NET INCOME (LOSS) AND EARNINGS (LOSS) PER SHARE Net loss and loss per share for Fiscal 1995 were $43.0 million and $3.03, respectively. This compared to a net loss and loss per share of $11.2 million and $0.79, respectively, in Fiscal 1994 and net income and earnings per share of $8.2 million and $0.56, respectively, in Fiscal 1993. The increase in net loss for Fiscal 1995 as compared to Fiscal 1994 was due principally to lower average store sales and $22.0 million of reorganization charges incurred during fiscal 1995. The net loss for Fiscal 1994 as compared to Fiscal 1993 was due to increases in cost of sales and selling, general and administrative expenses as a percentage of total revenues. - -------------------------------------------------------------------------------- LIQUIDITY AND CAPITAL RESOURCES Chapter 11 Filing As discussed previously, the Company and five of its subsidiaries filed voluntary petitions for relief under chapter 11 of title 11 of the United States Code on December 8, 1995. Under chapter 11, actions to enforce certain claims against the Company are stayed if the claims arose, or are based on, events that occurred on or before the Petition Date. The ultimate terms of settlement of these claims will be determined in accordance with a plan of reorganization which requires the approval of the impaired prepetition creditors and shareholders and confirmation by the Bankruptcy Court. Until a plan of reorganization is confirmed by the Bankruptcy Court, only such payments on prepetition obligations that are approved or required by the Bankruptcy Court will be made. Except as approved by the Bankruptcy Court, principal and interest payments on prepetition debt have not been made since the Petition Date and will not be made without the Bankruptcy Court's approval or until a plan of reorganization, defining the repayment terms, has been confirmed by the Bankruptcy Court. As a result, $53.4 million has been established as liabilities subject to compromise. Other liabilities may arise or be subject to compromise as a result of rejection of executory contracts, and unexpired leases or the Bankruptcy Court's resolution of claims for contingencies and other disputed amounts. 20 23 The prohibition on payments of prepetition liabilities as a result of the chapter 11 filing enabled the Company to report $34.5 million in cash and cash equivalents at January 27, 1996. Inherent in a successful plan of reorganization is a capital structure which permits the Company to generate sufficient cash flow after reorganization to meet its restructured obligations and fund the current obligations of the reorganized Company. Under the Bankruptcy Code, the rights of and ultimate payment to prepetition creditors may be substantially altered and, as to some classes, eliminated. At this time, it is not possible to predict the outcome of the chapter 11 filing, in general, or its effects on the business of the Company or on the interests of creditors or shareholders. The Company is in the process of developing a long term business plan around which the framework of a plan of reorganization will be developed. As a part of this process, the Company will be assessing the effects of new merchandising and marketing strategies on operating results and assessing the desirability of further store closings. Further store closings and rejections of leases and other executory contracts will result in increased reorganization costs. The exclusive period for the filing of a plan of reorganization has been extended to August 30, 1996 and to solicit acceptances of a plan of reorganization to October 31, 1996. The Company anticipates seeking further extensions of the exclusive period; however, there can be no assurance that the Bankruptcy Court will grant further extensions. The Company cannot, at the present time, predict the contents of any proposed plan of reorganization or when or whether it will be accepted by the creditors or approved by the Bankruptcy Court. Subsequent to the chapter 11 filing, the Company reached an agreement with The CIT Group/Business Credit, Inc. to provide debtor in possession financing (the "DIP Facility"). The DIP Facility was approved by the Bankruptcy Court on January 9, 1996. The DIP Facility provides for revolving loans to be made up to the lesser of (a) $40 million or (b) the lesser of (i) 60% of eligible inventory valued on a cost basis and (ii) 36.5% of eligible inventory valued on a retail basis, subject to adjustment. Up to $25 million of the revolving line of credit may be in the form of letters of credit determined as provided under the agreement. Cash borrowings bear interest at either a reference rate plus 0.5% or LIBOR plus 2.5%, at the option of the Company. The agreement contains various restrictive covenants requiring, among other things, minimum levels of earnings before interest, income taxes, depreciation and amortization, the establishment of maximum levels of capital expenditures, and a prohibition regarding declaring or making any cash dividends by the Company or its subsidiaries. The Company did not use the direct borrowing capacity on the line during Fiscal 1995. There were $2.4 million of letters of credit outstanding at January 27, 1996. The DIP Facility will terminate on the earlier of December 8, 1997 or the date of consummation of a plan of reorganization, subject to earlier termination. Cash borrowings and letters of credit issued under the agreement have been granted superpriority status by the Bankruptcy Court over all obligations except certain administrative expenses, as defined in the agreement. The DIP Facility agreement is more fully described in Note C to the Consolidated Financial Statements. General The Company's principal needs for liquidity are to finance the purchase of merchandise inventories, fund its operations and pay professional and administrative fees in connection with its reorganization. 21 24 Net cash provided by operating activities for Fiscal 1995, Fiscal 1994 and Fiscal 1993 was $8.5 million, $4.5 million and $5.3 million, respectively. The Company's cash provided by operating activities of $8.5 million in Fiscal 1995 resulted primarily from prepetition liabilities converted to liabilities subject to compromise (as a result of the Company's chapter 11 filing), the add back of non-cash charges representing non-cash reorganization costs and depreciation, offset by operating losses incurred during Fiscal 1995. Merchandise inventories decreased to $8.6 million at Fiscal 1995 year end, compared to $24.8 million at the end of Fiscal 1994. The decrease was primarily due to a net reduction of 177 stores by the end of Fiscal 1995, aggressive markdowns taken in the fourth quarter of Fiscal 1995, and a delay in receiving merchandise due to the initial uncertainty in the vendor and factor community caused by the chapter 11 filing until the DIP financing was approved. The Company has an indirect relationship with the factoring community, which assists vendors of merchandise inventories in securing up front payment (as opposed to payment terms from the Company directly) for goods shipped to the Company. Subsequent to the approval of the DIP Facility, factors have been willing to extend credit for goods shipped to the Company. To the extent that cash provided from operating activities is inadequate to meet the Company's liquidity requirements, the factors require greater credit support and/or manufacturers are less willing to deliver merchandise pursuant to payment terms, short or long-term liquidity will be adversely impacted. Income taxes receivable increased to $9.3 million in Fiscal 1995 from $5.4 million in Fiscal 1994. The Company's Fiscal 1995 loss will be carried back and will generate a refund from previous taxes paid. This carryback fully exhausts all taxes paid in prior years which are available for refund. The Company has recorded a valuation allowance to fully offset the potential tax benefit of the remaining net operating loss carryforward of $9.4 million. The components of income taxes are more fully described in Note G to the Consolidated Financial Statements. Net property, plant and equipment decreased to $27.9 million at the end of Fiscal 1995, compared with $50.0 million at the end of Fiscal 1994. The decrease primarily resulted from disposals of leasehold improvements and furniture, fixtures and equipment associated with the closing of 183 store locations during Fiscal 1995. Other assets decreased $1.2 million from the end of Fiscal 1994 to the end of Fiscal 1995 due to a decrease of $1.0 million resulting from the termination of the corporate-owned life insurance program and a decrease of $0.2 million in various other components. Accounts payable decreased to $11.1 million in Fiscal 1995 from $19.2 million in Fiscal 1994. The decrease was primarily attributable to a reduction in merchandise inventories, as explained above. Accrued sales tax decreased to $2.0 million in Fiscal 1995 from $2.9 million in Fiscal 1994 due to a decrease in Fiscal 1995 January sales over the same period for Fiscal 1994 and payment timing differences. Other accrued liabilities decreased to $8.4 million in Fiscal 1995 from $20.2 million in Fiscal 1994. The decrease resulted primarily from prepetition liabilities being converted to liabilities subject to compromise as a result of the Company's chapter 11 filing. Capital expenditures in Fiscal 1995 amounted to $0.9 million, primarily for the opening of six new stores and various store and corporate maintenance expenditures. During Fiscal 1996, the Company has earmarked $2.0 million for capital expenditures. Although the Company plans no new store openings during Fiscal 1996, capital expenditures for store maintenance, system enhancements and various other corporate expenditures are anticipated. The DIP Facility, cash on hand, revenues generated from operations, credit terms extended by the vendor and factor community, anticipated tax refunds and anticipated expense reduction measures will be the principal sources of liquidity. See Note K to the Consolidated Financial Statements for a description of litigation involving the Tax Refund. Although the Company believes that these sources will be sufficient to meet the Company's operating and capital requirements, the Company is unable to predict the extent to which the negative retail apparel environment will continue at its current or at an accelerated rate and the extent to which the public will accept the Company's merchandise during the bankruptcy period. To the extent that results of operations continue to decline, short and long term liquidity will be adversely affected, particularly if the availability of funds under the DIP Facility are significantly decreased or are no longer made available. 22 25 - -------------------------------------------------------------------------------- IMPACTS OF INFLATION The Company's financial condition and results of operations are presented on a historical cost basis. While it is difficult to accurately measure the impact of inflation due to the imprecise nature of the estimates required, the Company believes that the effects of inflation, if any, on the financial condition and results of operations have been relatively minor. - -------------------------------------------------------------------------------- FORWARD-LOOKING STATEMENTS Included in the Chairman's Letter Item 1. Business and Management's Discussion and Analysis of Financial Condition and Results of Operations are certain forward-looking statements reflecting management's current expectations. Although the Company believes that its expectations are based upon reasonable assumptions, there can be no assurance that the Company's financial goals will be realized. Numerous factors may affect the Company's actual results and may cause results to differ materially from those expressed in forward-looking statements made by or on behalf of the Company. Some of these factors include the competition in the retail industry and in the women's specialty market segment, the general economic factors affecting consumer spending particularly in the geographic markets in which the Company competes, customer acceptance of the merchandise offered by the Company, pricing and other competitive factors. The Company cannot predict how these factors will be additionally impacted by the Company's chapter 11 filing. In addition, there are uncertainties inherent in the process of reconciling claims, rejecting and assuming executory contracts and unexpired leases, formulating and confirming a plan of reorganization and other events in the context of the Company's chapter 11 filing. 23 26 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA CONSOLIDATED BALANCE SHEETS
January 27, 1996 January 28, 1995 - ------------------------------------------------------------------------------------------------------------- ASSETS CURRENT ASSETS Cash and cash equivalents $ 34,477,823 $ 40,829,741 Marketable securities 3,191,737 7,682,273 Merchandise inventories 8,551,207 24,812,265 Income taxes receivable 9,336,008 5,350,284 Prepaid expenses and other current assets 2,707,926 2,650,227 Deferred income taxes 471,000 5,560,677 - ----------------------------------------------------------------------------------------------------------- TOTAL CURRENT ASSETS 58,735,701 86,885,467 Investments 1,174,497 1,880,238 Property, plant and equipment - on the basis of cost Land and building 1,925,907 1,925,907 Furniture, fixtures, and equipment 20,635,176 26,235,945 Leasehold improvements 32,720,548 47,510,069 - ----------------------------------------------------------------------------------------------------------- 55,281,631 75,671,921 Less: accumulated depreciation and amortization (27,384,443) (25,686,104) - ----------------------------------------------------------------------------------------------------------- Net property, plant and equipment 27,897,188 49,985,817 Other assets 472,766 1,650,606 - ----------------------------------------------------------------------------------------------------------- $ 88,280,152 $ 140,402,128 - ----------------------------------------------------------------------------------------------------------- LIABILITIES AND SHAREHOLDERS' EQUITY CURRENT LIABILITIES Accounts payable $ 11,074,076 $ 19,161,810 Accrued sales taxes 1,982,300 2,918,754 Accrued payroll and related taxes 4,629,524 4,030,168 Other accrued liabilities 8,378,305 20,177,354 - ----------------------------------------------------------------------------------------------------------- TOTAL CURRENT LIABILITIES 26,064,205 46,288,086 LONG-TERM LIABILITIES Long-term debt - 37,234,019 Deferred income taxes 471,000 5,966,332 - ----------------------------------------------------------------------------------------------------------- TOTAL LONG-TERM LIABILITIES 471,000 43,200,351 LIABILITIES SUBJECT TO COMPROMISE 53,433,703 - SHAREHOLDERS' EQUITY Common stock, $.001 par value, authorized 50,00,000 shares, issued and outstanding 14,198,241 shares and 14,181,346 shares at January 27, 1996 and January 28, 1995, respectively 14,763 14,746 Additional paid-in capital 10,861,514 10,828,773 Retained earnings 2,301,860 45,304,232 Less: Treasury stock, 565,000 shares at cost at January 27, 1996 and January 28, 1995, respectively (4,850,215) (4,850,215) Securities valuation allowance (16,678) (383,845) - ----------------------------------------------------------------------------------------------------------- TOTAL SHAREHOLDERS' EQUITY 8,311,244 50,913,691 COMMITMENTS AND CONTINGENCIES - ----------------------------------------------------------------------------------------------------------- $ 88,280,152 $ 140,402,128 - -----------------------------------------------------------------------------------------------------------
See Notes to Consolidated Financial Statements 24 27 CONSOLIDATED STATEMENTS OF OPERATIONS
Year Ended ------------------------------------------------------ January 27, 1996 January 28, 1995 January 29, 1994 (52 Weeks) (52 Weeks) (52 Weeks) - ----------------------------------------------------------------------------------------------------------- REVENUES: Net sales $ 308,230,685 $ 340,800,733 $ 347,569,165 Interest and other income 578,767 1,479,136 1,912,688 - --------------------------------------------------------------------------------------------------------- Total Revenues 308,809,452 342,279,869 349,481,853 - --------------------------------------------------------------------------------------------------------- COSTS AND EXPENSES: Cost of sales, including buying and distribution and occupancy costs 236,872,079 245,543,337 237,766,331 Selling, general and administrative expenses 101,107,238 110,565,360 95,306,978 Loss on disposal of property, plant and equipment - 3,377,637 1,739,597 Interest expense 769,162 856,348 70,803 Other expenses 1,102,697 411,011 90,420 - --------------------------------------------------------------------------------------------------------- Total Costs and Expenses 339,851,176 360,753,693 334,974,129 - --------------------------------------------------------------------------------------------------------- INCOME (LOSS) BEFORE REORGANIZATION COSTS AND INCOME TAXES (31,041,724) (18,473,824) 14,507,724 Reorganization costs 21,966,648 - - - --------------------------------------------------------------------------------------------------------- INCOME (LOSS) BEFORE INCOME TAXES (53,008,372) (18,473,824) 14,507,724 Provision (benefit) for income taxes (10,006,000) (7,233,000) 6,340,000 - --------------------------------------------------------------------------------------------------------- NET INCOME (LOSS) $ (43,002,372) $ (11,240,824) $ 8,167,724 - --------------------------------------------------------------------------------------------------------- EARNINGS (LOSS) PER SHARE $ (3.03) $ (0.79) $ 0.56 Weighted average number of common and common equivalent shares outstanding during the year 14,190,482 14,160,647 14,660,232 - ---------------------------------------------------------------------------------------------------------
See Notes to Consolidated Financial Statements 25 28 CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
Common Stock Additional Securities -------------------------- Paid-In Retained Treasury Stock Valuation Number of Shares Amount Capital Earnings At Cost Allowance Total - ---------------------------------------------------------------------------------------------------------------------------------- BALANCES AT JANUARY 30, 1993 14,121,187 $14,621 $10,160,366 $ 48,377,332 $ (4,342,699) $ - $ 54,209,620 Proceeds from exercise of stock options 96,262 96 312,158 - - - 312,254 Tax benefit of nonqualifying options - - 284,302 - - - 284,302 Treasury stock (65,000) - - - (507,516) - (507,516) Net income for the year - - - 8,167,724 - - 8,167,724 - ---------------------------------------------------------------------------------------------------------------------------------- BALANCES AT JANUARY 29, 1994 14,152,449 14,717 10,756,826 56,545,056 (4,850,215) - 62,466,384 Proceeds from exercise of stock options 28,897 29 46,676 - - - 46,705 Tax benefit of nonqualifying options - - 25,271 - - - 25,271 Change in securities valuation allowance - - - - - (383,845) (383,845) Net loss for the year - - - (11,240,824) - - (11,240,824) - ---------------------------------------------------------------------------------------------------------------------------------- BALANCES AT JANUARY 28, 1995 14,181,346 14,746 10,828,773 45,304,232 (4,850,215) (383,845) 50,913,691 Proceeds from exercise of stock options 16,895 17 32,741 - - - 32,758 Change in securities valuation allowance - - - - - 367,167 367,167 Net loss for the year - - - (43,002,372) - - (43,002,372) - ---------------------------------------------------------------------------------------------------------------------------------- BALANCES AT JANUARY 27, 1996 14,198,241 $14,763 $10,861,514 $ 2,301,860 $ (4,850,215) $ (16,678) $ 8,311,244 ==================================================================================================================================
See Notes to Consolidated Financial Statements 26 29 CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended ----------------------------------------------------- January 27, 1996 January 28, 1995 January 29, 1994 (52 Weeks) (52 Weeks) (52 Weeks) - ---------------------------------------------------------------------------------------------------------------------------------- OPERATING ACTIVITIES: Net income (loss) $(43,002,372) $(11,240,824) $ 8,167,724 Adjustments to reconcile net income (loss) to net cash provided by operating activities: Noncash reorganization costs 18,346,070 - - Depreciation and amortization 9,968,462 6,715,799 6,634,313 Deferred income taxes (653,138) 271,806 (1,232,000) Loss on marketable securities and investments 1,110,697 411,011 - Loss on disposal of property, plant and equipment - 3,377,637 1,739,597 Changes in operating assets and liabilities: (Increase) decrease in merchandise inventories 16,261,058 7,047,320 (8,620,108) Increase in income taxes receivable (3,985,724) (5,325,013) - (Increase) decrease in prepaid expenses and other assets 860,846 805,985 (1,466,244) Increase (decrease) in accounts payable 12,683,506 3,023,369 (4,389,457) Increase (decrease) in accrued payroll and related taxes 599,356 (1,679,166) 274,701 Increase (decrease) in accrued sales tax and other accrued liabilities (3,645,939) 4,407,046 3,770,781 Increase (decrease) in income taxes payable - (3,353,593) 465,921 - -------------------------------------------------------------------------------------------------------------------------------- NET CASH PROVIDED BY OPERATING ACTIVITIES 8,542,822 4,461,377 5,345,228 - -------------------------------------------------------------------------------------------------------------------------------- INVESTING ACTIVITIES: Investment in marketable securities (18,370) (3,396,023) (12,891,651) Proceeds from sales of marketable securities 4,718,600 15,298,719 11,582,674 Purchases of long-term investments - - (1,880,238) Purchases of property, plant, and equipment (914,128) (13,843,751) (17,792,508) Proceeds from sale of property, plant and equipment 112,000 1,109,039 - - -------------------------------------------------------------------------------------------------------------------------------- NET CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES 3,898,102 (832,016) (20,981,723) - -------------------------------------------------------------------------------------------------------------------------------- FINANCING ACTIVITIES: Net borrowings (repayments) under revolving credit facilities (19,545,738) 35,153,000 - Proceeds from other long-term borrowings 1,400,000 - 1,890,000 Principal payments under long-term debt (679,862) (705,013) (280,716) Proceeds from the exercise of stock options 32,758 46,705 312,254 Purchase of common stock for treasury - - (507,516) - -------------------------------------------------------------------------------------------------------------------------------- NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES (18,792,842) 34,494,692 1,414,022 - -------------------------------------------------------------------------------------------------------------------------------- INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (6,351,918) 38,124,053 (14,222,473) Cash and cash equivalents at beginning of year 40,829,741 2,705,688 16,928,161 - -------------------------------------------------------------------------------------------------------------------------------- CASH AND CASH EQUIVALENT AT END OF YEAR $ 34,477,823 $ 40,829,741 $ 2,705,688 - -------------------------------------------------------------------------------------------------------------------------------- SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: - -------------------------------------------------------------------------------------------------------------------------------- Income taxes paid $ 16,325 $ 1,186,218 $ 5,816,553 - -------------------------------------------------------------------------------------------------------------------------------- Interest paid $ 761,116 $ 727,351 $ 70,803 - -------------------------------------------------------------------------------------------------------------------------------- Income tax refunds received $ 5,372,198 $ - $ 160,263 - -------------------------------------------------------------------------------------------------------------------------------- SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND FINANCING ACTIVITIES: Equipment acquired under capital leases $ - $ - $ 1,909,725 - --------------------------------------------------------------------------------------------------------------------------------
See Notes to Consolidated Financial Statements 27 30 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS January 27, 1996, January 28, 1995 and January 29, 1994 - -------------------------------------------------------------------------------- NOTE A REORGANIZATION AND BASIS OF REPORTING On December 8, 1995, (the "Petition Date"), The Clothestime, Inc. ("Clothestime") and five of its subsidiaries (MRJ Industries, Inc. ("MRJ"), Clothestime Stores, Inc. ("Stores"), Clothestime Investment, Inc., Clothestime Acquisition Corporation and Clothestime International, Inc.) (collectively, the "Debtors") commenced reorganization cases (the "Bankruptcy Cases") by filing voluntary petitions for relief under chapter 11, Title 11 of the United States Code (the "Bankruptcy Code") in the United States Bankruptcy Court for the Central District of California, Santa Ana Division (the "Bankruptcy Court"). For purposes of this Report, unless otherwise referenced, the defined term "Company" shall apply to Clothestime and its consolidated group of subsidiaries, except that references to the Company in connection with any disclosure relating to the Debtors' chapter 11 cases refer solely to the Debtors and exclude Clothestime Insurance Company (Clothestime's captive insurance company subsidiary). The Debtors decided to seek bankruptcy protection after an extensive review of the current retail environment and the Debtors' operations. Management of each of the respective companies determined that filing the chapter 11 petitions would allow the Debtors the needed time and flexibility to restructure their respective operations. Since the Petition Date, the Debtors have continued in possession of their properties and, as debtors in possession, are authorized to operate and manage each of their respective businesses and enter into all transactions (including obtaining services, supplies and inventories) that each could have entered into in the ordinary course of business had there been no bankruptcy filings. As debtors in possession, the Debtors may not engage in transactions outside of the ordinary course of business without approval of the Bankruptcy Court, after notice and hearing. Liabilities subject to compromise in the accompanying consolidated balance sheets represent the Company's estimate of liabilities as of January 27, 1996, subject to adjustment in the reorganization process. Under chapter 11, actions to enforce certain claims against the Company are stayed if the claims arose, or are based on events that occurred, on or before the Petition Date. Other liabilities may arise or be subject to compromise as a result of rejection of executory contracts, including leases (see Note J), or the Bankruptcy Court's resolution of claims for contingencies and other disputed amounts. As a general matter, the treatment of these liabilities will be determined as a part of the formulation and confirmation of a plan of reorganization. See Note D. The accompanying consolidated financial statements have been presented on the basis that the Company is a going concern, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. As a result of the chapter 11 filing and circumstances relating to this event, realization of assets and satisfaction of liabilities is subject to uncertainty. A plan of reorganization could materially change the amounts reported in the accompanying consolidated financial statements, which do not give effect to adjustments to the carrying values of assets and liabilities which may be necessary as a consequence of a plan of reorganization. The ability of the Company to continue as a going concern is dependent on, among other things, confirmation of an acceptable plan of reorganization, future profitable operations, compliance with the debtor-in possession financing agreement (see Note C), and the ability to generate sufficient cash from operations and obtain financing sources to meet future obligations. - -------------------------------------------------------------------------------- NOTE B SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES BUSINESS: The principal business of the Company is the retail sale of junior size women's clothing. As of January 27, 1996, the Company operated stores in 20 states and Puerto Rico, with a large concentration of stores in California, Florida and Texas. PRINCIPLES OF CONSOLIDATION: The consolidated financial statements include the accounts of The Clothestime, Inc. and its consolidated group of subsidiaries, MRJ, Stores, Clothestime Insurance Company, Clothestime International, Inc., Clothestime Investment, Inc., and Clothestime Acquisition Corporation. MRJ serves as a purchasing and distribution company, as well as a management company, providing administrative services to the other subsidiaries in the consolidated group. Stores was incorporated to own and operate all of the existing and future retail operations. Clothestime Insurance Company was established as a captive insurance company. Clothestime International, Inc. was established to facilitate anticipated international expansion. Clothestime Investment, Inc. was established to manage investments, and Clothestime Acquisition Corporation was established to provide uniform financing for the Company's subsidiaries and to acquire other business ventures in the future. All material intercompany balances and transactions have been eliminated in consolidation. 28 31 CASH EQUIVALENTS: The Company considers all highly liquid investments with an original maturity of three months or less to be cash equivalents. Approximately $3.1 million is held in segregated accounts pursuant to a stipulation with a prepetition lender. MARKETABLE SECURITIES: Investments in securities which do not meet the definition of cash equivalents are classified as marketable securities. Marketable securities consist of U.S. and state government agency issues. Statement of Financial Accounting Standards No. 115, "Accounting for Certain Investments in Debt and Equity Securities" ("SFAS 115"), was adopted by the Company at the beginning of Fiscal 1994. SFAS 115 requires that investments be classified as "held to maturity," "available for sale" or "trading securities". The statement defines investments in securities as "held to maturity" based upon a positive intent and ability to hold those securities. Securities that are bought and held principally for the purpose of selling them in the near term are classified as "trading securities" and would be reported at fair value, with unrealized gains and losses included in operations. Debt and equity securities not classified as "held to maturity" or "trading securities" are classified as "available for sale" and would be recorded at fair value, with unrealized gains and losses excluded from operations and reported as a separate component of equity. At January 27, 1996, the Company classified all of its investments in securities which did not meet the definition of cash equivalents as marketable securities available-for-sale. Management has determined that the effect of the change in accounting for investments as of January 30, 1994, and the effect upon the financial position as of January 28, 1995, was immaterial. MERCHANDISE INVENTORIES: Merchandise inventories are accounted for by the retail inventory method and are stated at the lower of cost (first-in, first-out method) or market. PROPERTY, PLANT AND EQUIPMENT: Depreciation of property, plant and equipment (excluding land) is provided for by the straight-line method over the estimated useful lives of the related assets. Assets held under capital leases and leasehold improvements, including certain lease acquisition costs, are amortized by the straight-line method, over the lesser of related lease terms or the estimated useful lives of such assets. ADVERTISING COSTS: Advertising costs are expensed as incurred. Selling, general and administrative expenses of the Company include advertising costs of approximately $15.0 million, $17.1 million and $13.3 million for Fiscal 1995, Fiscal 1994 and Fiscal 1993, respectively. INCOME TAXES: The Company accounts for income taxes under Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes" ("SFAS 109"). This Statement requires recognition of deferred tax liabilities and assets for the expected future tax consequences of events that have been included in the financial statements or tax returns. Under this method, deferred tax assets and liabilities are determined based on the difference between the financial statement and tax bases of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. REVENUE RECOGNITION: Revenue is recognized at the point of sale. EARNINGS (LOSS) PER SHARE: The computation of earnings (loss) per common and common equivalent share is based upon the weighted average number of common shares outstanding during the period plus (in periods in which they have a dilutive effect) the effect of common shares contingently issuable, primarily from stock options and warrants. Primary earnings per share approximates fully-diluted earnings per share. FISCAL YEAR: The fiscal year of the Company ends on the Saturday closest to January 31. Fiscal 1995, Fiscal 1994 and Fiscal 1993, refer to the years ended January 27, 1996, January 28, 1995 and January 29, 1994, respectively. REORGANIZATION COSTS: Professional fees, the write-off of assets and other costs and expenditures directly related to the chapter 11 filing are classified as reorganization costs. FAIR VALUE OF FINANCIAL INSTRUMENTS: In Fiscal 1995, the Company adopted Statement of Financial Accounting Standards No. 107, "Disclosures about Fair Value of Financial Instruments." The carrying amount of cash and cash equivalents, income taxes receivable, accounts payable and accrued liabilities approximate fair value because of the short-term maturity of these financial instruments. As a result of the Company's chapter 11 filing, a limited market has developed for the trading of financial instruments included in liabilities subject to compromise. Since the market for claims against the companies under chapter 11 is not well developed, no reliable source of market price is available. 29 32 CURRENT ACCOUNTING PRONOUNCEMENTS: In November 1995, Statement of Financial Accounting Standards No. 123 ("SFAS 123"), "Accounting for Stock-Based Compensation" was issued. This statement establishes financial accounting standards for stock-based employee compensation plans. SFAS 123 permits the Company to choose either a new fair value based method or the current APB Opinion 25 intrinsic value based method of accounting for its stock-based compensation arrangements. SFAS 123 requires pro forma disclosures of net income and earnings per share computed as if the fair value based method has been applied in financial statements of companies that continue to follow current practice in accounting for such arrangements under Opinion 25. SFAS 123 applies to all stock-based employee compensation plans in which an employer grants shares of its stock or other equity instruments to employees except for employee stock ownership plans. SFAS 123 also applies to plans in which the employer incurs liabilities to employees in amounts based on the price of the employer's stock, i.e., stock option plans, stock purchase plans, restricted stock plans and stock appreciation rights. The statement also specifies the accounting for transactions in which a company issues stock options or other equity instruments for services provided by non-employees or to acquire goods or services from outside suppliers or vendors. The recognition provisions of SFAS 123 for companies choosing to adopt the new fair value based method of accounting for stock-based compensation arrangements may be adopted immediately and will apply to all transactions entered into in fiscal years that begin after December 15, 1995. The disclosure provisions of SFAS 123 are effective for fiscal years beginning after December 15, 1995; however, disclosure of the pro forma net income and earnings per share, as if the fair value method of accounting for stock-based compensation had been elected, is required for all awards granted in fiscal years beginning after December 31, 1994. The Company intends to account for stock-based compensation under APB Opinion 25 and, as a result, SFAS 123 will not have a material impact on the Company's operations. USE OF ESTIMATES: Company management has made a number of estimates and assumptions relating to the reporting of assets and liabilities in conformity with generally accepted accounting principles. Actual results could differ from these estimates. RECLASSIFICATIONS: Certain amounts for the prior years have been reclassified to conform to the Fiscal 1995 presentation. - -------------------------------------------------------------------------------- NOTE C DEBTOR IN POSSESSION FINANCING On December 28, 1995, the Company, through Stores, entered into, and subsequently the Bankruptcy Court approved, a financing agreement with The CIT Group/Business Credit, Inc. (the "DIP Lender ") for debtor in possession financing (the "DIP Facility"). The agreement provides for revolving loans to be made up to the lesser of (a) $40 million or (b) the lesser of (i) sixty percent (60%) of eligible inventory valued on a cost basis and (ii) thirty-six and one half percent (36.5%) of eligible inventory valued on a retail basis, subject to adjustment. Up to $25 million of the revolving line of credit may be in the form of letters of credit determined as provided under the agreement. Cash borrowings bear interest at a reference rate plus one half of one percent (0.5%) per annum or, at the request of Stores, the London Interbank Rate plus two and one half percent (2.5%). The agreement calls for a loan facility fee of $250,000, a semi-annual inventory management fee of $30,000, an unused line fee of 3/8% per annum and a letter of credit fee of 1% per annum. As of January 27, 1996, the Company had not used the direct borrowing capacity on the line and had outstanding letters of credit in the amount of $2.4 million. The agreement contains various restrictive covenants requiring, among other things, minimum levels of earnings before interest, income taxes, depreciation and amortization, the establishment of maximum levels of capital expenditures, and a prohibition regarding declaring or making any cash dividends by the Company or its subsidiaries. In addition, the DIP Lender required a negative pledge on Stores' merchandise inventory and proceeds. To the extent currently required, the Company is in compliance with the restrictive covenants. The term of the DIP Facility is the earlier of December 8, 1997 or the effective date of the Debtors' confirmed plan of reorganization, subject to earlier termination. Cash borrowings and letters of credit issued under the agreement have been granted super priority status by the Bankruptcy Court over all obligations except certain administrative expenses, as defined in the agreement. 30 33 - -------------------------------------------------------------------------------- NOTE D LIABILITIES SUBJECT TO COMPROMISE Liabilities subject to compromise include substantially all of the current and noncurrent liabilities of the Company as of the Petition Date. These liabilities were transferred from their respective prepetition balance sheet accounts to liabilities subject to compromise and have been treated as noncash items in the accompanying Fiscal 1995 consolidated statement of cash flows. Certain prepetition liabilities have been approved by the Bankruptcy Court for payment. At January 27, 1996, such amounts to the extent not paid, were included in accrued expenses and other payables. Liabilities subject to compromise as of January 27, 1996 are summarized as follows: Revolving credit facility debt $15,607,262 Secured note payable to Wells Fargo Bank 1,358,000 Secured notes payable to Union Bank 1,174,497 Capital lease obligation 1,001,637 Accounts payable, trade 20,771,240 Estimated lease rejection claims 8,871,043 Other payables and accrued expenses 4,650,024 ----------- $53,433,703 ===========
Prior to the Petition Date, the revolving credit facility debt bore interest at the bank's prime rate plus 1% and was due February 1, 1997. The banks assert a security interest in substantially all of the assets of the Company and its subsidiaries, excluding merchandise inventories. The amount of revolving credit facility debt will be higher, and accounts payable, trade will be lower, by amounts paid under the credit facility pursuant to letters of credit. The note payable to Wells Fargo Bank is secured by an office/warehouse building and underlying real property that the Company uses to house a portion of its administrative offices and warehousing facilities. The note bears interest based on LIBOR plus 1.5% and was due March 1, 2005. The two notes payable to Union Bank, which are secured by limited partnership interests in low-income housing projects, bear interest at 6.1% and 6.2% and were due in September 1998 and January 1999. The capital lease obligation is secured by certain equipment acquired in connection with the capital lease agreement. The obligation matured through May 31, 1998, with the interest portion of the lease payments at a yield of 30 day commercial paper rate plus 235 basis points. The interest rates described above do not consider interest rates which may be applicable in the event of default. A plan of reorganization ultimately approved by the Company's impaired prepetition creditors and shareholders and confirmed by the Bankruptcy Court may materially change the amounts and terms of these prepetition liabilities. The Company anticipates that it will negotiate with creditors to reconcile claims filed with the Bankruptcy Court to the Company's financial records. The additional liability arising from this reconciliation process, if any, is not subject to reasonable estimation. As a result, no provision has been recorded for these possible claims. The Company will recognize the additional liability, if any, as the amounts become subject to reasonable estimation. Additional bankruptcy claims and prepetition liabilities may arise from the rejection of executory contracts and unexpired leases, resolution of contingent and unliquidated claims and the settlement of disputed claims. Consequently, the amounts included in the consolidated balance sheets as liabilities subject to compromise may be subject to further adjustment. In accordance with the American Institute of Certified Public Accountants' Statement of Position 90-7, "Financial Reporting by Entities in Reorganization Under the Bankruptcy Code" (SOP 90-7), the Company is not required to record interest during chapter 11 proceedings on unsecured or undersecured prepetition debt. Interest expense on certain secured debt will continue to be accrued but is subject to settlement. No determination has been made regarding the value of the property interests which secure certain debt and, consequently, whether interest thereon will be paid. The Company has continued accruing interest on its secured prepetition debt obligations, except for the $15,607,262 revolving credit facility debt, which the Company believes is undersecured. However, the Bankruptcy Court could determine that postpetition interest should be paid on this obligation. Contractual interest (computed without regard to default rates of interest) exceeds interest expense recorded in the accompanying Fiscal 1995 consolidated statement of operations by approximately $235,000. 31 34 NOTE E REORGANIZATION COSTS Reorganization costs recorded in Fiscal 1995 consisted of: Write-off of leasehold improvements and fixtures associated with store closures $ 9,612,448 Estimated store lease rejection claims 8,464,480 Other related store closure costs 1,852,423 Professional fees 1,744,680 Write-off of unamortized deferred financing costs associated with prepetition debt 259,295 Other 33,322 ----------- $21,966,648 ===========
- -------------------------------------------------------------------------------- NOTE F CAPITAL STOCK AND STOCK OPTIONS The Company grants stock options under its various stock option plans to key employees, officers and directors of the Company. With respect to incentive options, the option price may not be less than the fair market value of the stock at the date of grant and with respect to nonstatutory options, the option price may not be less than 85% of the fair market value of the stock at the date of grant. Transactions under the various plans are summarized as follows:
Year Ended -------------------------------------------------------- January 27, 1996 January 28, 1995 January 29, 1994 - ---------------------------------------------------------------------------------------------------- Options outstanding, beginning of year 2,708,665 2,528,432 1,621,941 - -------------------------------------------------------------------------------------------------- Options granted 622,500 444,200 1,205,450 (per share amounts): 1995, $2.75 to $3.19 1994, $3.63 to $7.63 1993, $8.25 to $12.50 - -------------------------------------------------------------------------------------------------- Options exercised (16,895) (28,897) (96,262) (per share amounts): 1995, $1.50 to $2.13 1994, $1.50 to $4.25 1993, $1.50 to $8.88 - -------------------------------------------------------------------------------------------------- Options canceled (498,482) (235,070) (202,697) (per share amounts): 1995, $1.50 to $12.50 1994, $1.50 to $12.75 1993, $1.50 to $12.75 - -------------------------------------------------------------------------------------------------- Options outstanding, end of year 2,815,788 2,708,665 2,528,432 - --------------------------------------------------------------------------------------------------
At January 27, 1996, options to purchase 1,867,363 shares of the Company's common stock were exercisable on various dates through December 9, 2004, at prices ranging from $1.50 to $12.75 per share. In addition, at January 27, 1996, there were options to purchase 1,075,542 shares of the Company's stock available for grant under the Company's stock option plans. 32 35 NOTE G INCOME TAXES The components of the provision (benefit) for income taxes are summarized as follows:
Year Ended ------------------------------------------------------ January 27, 1996 January 28, 1995 January 29, 1994 - --------------------------------------------------------------------------------- CURRENT: Federal $ (9,194,000) $ (5,925,000) $ 5,840,000 State 421,000 (203,000) 1,732,000 - ------------------------------------------------------------------------------- Total Current (8,773,000) (6,128,000) 7,572,000 - ------------------------------------------------------------------------------- DEFERRED: Federal (898,000) (727,000) (390,000) State (335,000) (378,000) (842,000) - ------------------------------------------------------------------------------- Total Deferred (1,233,000) (1,105,000) (1,232,000) - ------------------------------------------------------------------------------- Total $(10,006,000) $ (7,233,000) $ 6,340,000 - -------------------------------------------------------------------------------
The actual provision (benefit) for income taxes differs from statutory tax for all years (computed by applying the Federal tax rate of 35% in Fiscal 1995, Fiscal 1994 and Fiscal 1993 to income (loss) before income taxes) as follows:
Year Ended ------------------------------------------------------- January 27, 1996 January 28, 1995 January 29, 1994 - ---------------------------------------------------------------------------------------------- Taxes (benefit) computed at Federal statutory rates $(18,553,000) $ (6,466,000) $ 5,078,000 Nontaxable revenue (77,000) (281,000) (552,000) Targeted jobs and other tax credits - (115,000) (88,000) State income taxes 86,000 (581,000) 865,000 Change in valuation allowance 9,085,000 - 1,051,000 Other, net (547,000) 210,000 (14,000) - -------------------------------------------------------------------------------------------- $(10,006,000) $ (7,233,000) $ 6,340,000 - --------------------------------------------------------------------------------------------
The tax effected cumulative temporary differences which give rise to deferred tax assets and liabilities under SFAS 109 are as follows:
January 27, 1996 January 28, 1995 January 29, 1994 - ------------------------------------------------------------------------------------------------------ Deferred tax assets: Deferred compensation and employee benefits $ 1,365,000 $ 921,000 $ 708,000 State and local taxes - - 600,000 Accrued liabilities 3,572,000 1,725,000 4,682,000 Inventories 931,000 942,000 249,000 Net operating loss carryforward 2,304,000 - - Alternative minimum credits 1,700,000 - - Charitable contributions and other tax deductible carryforwards 1,702,000 - - Depreciation and amortization including lease acquisition costs 740,000 - - Other 738,000 422,000 243,000 - ---------------------------------------------------------------------------------------------------- 13,052,000 4,010,000 6,482,000 Less: Valuation allowance (12,312,000) (3,227,000) (3,227,000) - ---------------------------------------------------------------------------------------------------- Total deferred tax assets 740,000 783,000 3,255,000 - ---------------------------------------------------------------------------------------------------- Deferred tax liabilities: Depreciation and amortization including lease acquisition costs 512,000 987,000 3,304,000 Prepaid expenses 228,000 202,000 332,000 - ---------------------------------------------------------------------------------------------------- Total deferred tax liabilities 740,000 1,189,000 3,636,000 - ---------------------------------------------------------------------------------------------------- Net deferred tax liability $ - $ 406,000 $ 381,000 - ----------------------------------------------------------------------------------------------------
The valuation allowance against deferred tax assets was increased by $9,085,000 in Fiscal 1995 and $1,051,000 in Fiscal 1993. The Company's Fiscal 1995 loss will be carried back and will generate a refund from previous taxes paid of $9.3 million. This carryback fully exhausts all taxes paid in prior years which are available for refund. The Company has recorded a valuation allowance to fully offset the remaining Federal net operating loss carryforward of $9.4 million. The Company has received notice from the Internal Revenue Service that it intends to audit the Company's Federal income tax returns for certain prior years. In the opinion of management, this examination will not have a material adverse effect on the Company's consolidated financial position or results of operations. 33 36 - -------------------------------------------------------------------------------- NOTE H MARKETABLE SECURITIES The carrying values (cost) and estimated market values of investment securities available-for-sale are summarized as follows:
U.S. State and Local Government Agency Issues ----------------------------------------------------- Gross Gross Unrealized Unrealized Fair Holding Holding Cost Value Losses Gains ----------------------------------------------------- As of January 27, 1996 $3,208,415 $3,191,737 $ 16,678 $ - - ------------------------------------------------------------------------------ As of January 28, 1995 $8,313,601 $7,682,273 $ 631,328 $ - - ------------------------------------------------------------------------------
Maturities of investment securities available-for-sale are summarized as follows:
Year Ended ---------- January 27, 1996 January 28, 1995 - ----------------------------------------------------------------------------------- Within 1 year $ - $3,791,838 After 1 year through 5 years 1,003,835 1,413,484 After 5 years through 10 years 2,204,580 3,108,279 After 10 years - - - -------------------------------------------------------------------------------- $3,208,415 $8,313,601 - --------------------------------------------------------------------------------
Year Ended ------------------------------------ January 27, 1996 January 28, 1995 - -------------------------------------------------------------------------------------------------- Proceeds from sales of investment securities available-for-sale $ 4,718,600 $15,298,719 Gross realized gains on sales of investment securities available-for-sale $ 5,490 $ 102,920 Gross realized losses on sales of investment securities available-for-sale $ 410,446 $ 513,931 Net unrealized holding loss on available-for-sale securities included as a component of stockholders' equity $ 16,678 $ 383,845
All realized gains and losses are computed on the specific identification basis. Investment securities available-for-sale include securities having a fair value of $2,196,000 held as collateral under the prepetition revolving credit facility debt (see Note D). - -------------------------------------------------------------------------------- NOTE I EMPLOYEE SAVINGS PLAN In February 1992, the Board of Directors approved "The Clothestime, Inc. Savings and Investment Plan", a 401(k) Savings Plan (the "401(k) Plan"). Under the provisions of the 401(k) Plan, beginning on April 1, 1992, all full-time employees who have completed one year of service and attained the age of 21 years may defer up to 15% of their compensation per year. Further, the Company may, upon approval of the Board, make a discretionary matching and/or profit sharing contribution to the plan. For Fiscal 1995, Fiscal 1994 and Fiscal 1993, the Board approved a 2% matching contribution. In Fiscal 1995, Fiscal 1994 and Fiscal 1993, the Company expensed $296,256, $273,324 and $208,998, respectively, for Company matching contributions. Prior to Fiscal 1995, the Company had a nonqualified deferred compensation plan (the "Deferred Compensation Plan") and a supplemental executive retirement plan (the "Supplemental Plan") for key employees and officers. Pursuant to the Deferred Compensation Plan, eligible employees were entitled to defer up to 90% of their compensation. Pursuant to the Supplemental Plan, the Company was required to make a 5% basic contribution for each employee who elected to defer at least 5% of his compensation under the Deferred Compensation Plan, had the discretion to match an employee's deferrals up to 10% of compensation and could elect to make an additional 10% contribution regardless of the employee's deferral amount. For Fiscal 1993, the Board approved Company contributions of 15% of the participants' compensation for one officer and 25% for four other officers. During Fiscal 1994, the Company elected to terminate the Deferred Compensation Plan and the Supplemental Plan and distribute the accrued benefits thereunder to the respective participants. In light of such termination, no amounts were deferred under the Deferred Compensation Plan and no Company contributions were made under the Supplemental Plan during Fiscal 1995 and Fiscal 1994. 34 37 - -------------------------------------------------------------------------------- NOTE J LEASES The Company occupies its retail stores, main warehouse and administrative facilities under non-cancelable operating leases. With the exception of the lease with the Partnership (discussed below) relating to the Company's main warehouse, distribution and administrative facilities, all of the Company's leases are with non-affiliated third parties. With respect to retail store facilities, the lease terms, including renewal options, range from one to twenty years and expire at various dates through 2007. Some leases contain renewal options for periods ranging from one to ten years under substantially the same terms and conditions as the original leases. Most of the leases require the Company to pay the greater of a specified minimum rental or a contingent rental based on a percentage of gross sales. Many leases include cancellation clauses exercisable by the Company upon the occurrence of certain events (e.g., change in anchor tenant or failure to reach certain minimum sales levels). During fiscal 1992, the Company leased a building from a non-affiliated third party in close proximity to its main warehouse and administrative facilities in order to accommodate the need for expansion of warehousing and administrative facilities. The lease term commenced on June 1, 1992 and was due to expire on December 31, 1994. In December 1994, the Company purchased the property for $50,000 and paid off the underlying encumbrances of the first trust deed (a second trust deed was paid off in Fiscal 1992) for a total of approximately $1.9 million. This office and warehouse building is security for a $1.4 million loan agreement between Stores and Wells Fargo Bank and a $40 million credit facility among Stores, Wells Fargo Bank and Union Bank (see Note D). The loan agreement and credit facility are both also guaranteed by Clothestime and certain other of its subsidiaries. The building consists of approximately 25,700 square feet of two-story office space and approximately 24,600 square feet of warehouse space. During fiscal 1986, the Company leased a 22,389 square foot building from a non-affiliated third party near its main warehouse and administrative facilities, primarily to provide additional warehouse and storage space. Such facility was used by the Company throughout the fiscal year ending January 27, 1996, however the lease of the facility was rejected effective February 15, 1996. In fiscal 1983, the Company leased a corporate warehouse and administrative facility located on a five-acre tract in Anaheim, California, from a partnership (the "Partnership") comprised of: John Ortega II (a director, principal shareholder and an executive officer), Raymond A. DeAngelo and Michael P. DeAngelo (former directors and executive officers of the Company); and August DeAngelo (a former director of the Company). The office and distribution center consist of approximately 27,000 square feet of two-story office space and approximately 82,400 square feet of warehouse space. In fiscal 1988, the Company entered into a new lease (the "Lease") with the Partnership respecting three parcels of real property which include the five-acre tract on which the Company's main corporate warehouse and administrative facility is located and two unimproved parcels (one of which is adjacent to the aforementioned five-acre parcel). The Lease expires in November 1998. Rent for the first year was 52 cents per square foot per month (an initial annual rent of $682,956) plus insurance, taxes, maintenance and other incidental costs. In subsequent years, the monthly rental adjusts with the Consumer Price Index ("CPI"); however, the minimum monthly rent in no event is less than 104% or more than 108% of the minimum rent in effect immediately preceding the adjustment. The Company has the option to extend the term of the Lease for an additional five-year period. Rent during the five-year extension is to be adjusted to the then prevailing market rate, subject to annual CPI increases. Subject to the Company's right to reject leases as stated below, the Company is currently attempting to reduce its occupancy costs, including minimum monthly rent, under the Lease through negotiations with the Partnership. Pursuant to the Lease, the Company paid the Partnership during Fiscal 1995, Fiscal 1994 and Fiscal 1993 rent of $886,471, $851,487 and $815,270, respectively. In Fiscal 1995, Fiscal 1994 and Fiscal 1993 property taxes were paid directly by the Company. In the opinion of the Company, the terms of the above-described agreements with the Partnership are fair and reasonable and as favorable to the Company as those which could have been obtained from unrelated third parties at the time of their execution. Subject to the approval of the Bankruptcy Court, the Company can reject executory contracts, including leases, under the relevant provisions of the Bankruptcy Code. Rejection of a lease gives the lessor the right to assert a prepetition claim against the Company as though the lease had been terminated immediately before the date of the chapter 11 filing. However, the amount of the claim may be limited by the Bankruptcy Code. Estimated allowed claims for rejected leases are included in reorganization costs. The analysis of lease commitments below has been adjusted to reflect the closing of 137 stores in connection with the chapter 11 filing (see Note A), but has not been adjusted to reflect possible future lease rejections. 35 38 Future minimum payments, by fiscal year and in the aggregate, under non-cancelable operating leases, including the lease of the main warehouse and administrative facility discussed above, with initial or remaining terms of one year or more consisted of the following at January 27, 1996:
Portion Attributable to Related Party Lease Fiscal Year Total Expense - -------------------------------------------------------------------------------- 1996 $ 23,767,263 $ 921,882 1997 20,737,096 958,757 1998 18,218,550 830,920 1999 16,185,770 - 2000 13,086,196 - Thereafter 24,618,829 - - ------------------------------------------------------------------------------- $116,613,704 $2,711,559
Rent expense for all non-cancelable operating leases consisted of the following:
Minimum Rentals Contingent Rentals Grand Total ----------------------------- --------------------------- ------------------------------ Portion Portion Portion Attributable to Attributable to Attributable to Related Party Related Party Related Party Fiscal Year Ended Total Lease Expense Total Lease Expense Total Lease Expense - ------------------------------------------------------------------------------------------------------------------ January 27, 1996 $36,537,451 $886,471 $ 83,482 $ - $36,620,933 $886,471 January 28, 1995 $36,766,065 $851,487 $153,604 $ - $36,919,669 $851,487 January 29, 1994 $31,971,963 $815,270 $261,858 $ - $32,233,821 $815,270
- -------------------------------------------------------------------------------- NOTE K LEGAL PROCEEDINGS On December 8, 1995, Clothestime and five of its subsidiaries (Stores, MRJ, Clothestime Acquisition Corporation, Clothestime Investment, Inc. and Clothestime International, Inc.) filed petitions in the United States Bankruptcy Court for the Central District of California, Santa Ana Division, Jointly Administered Case No. SA95-22533JW, seeking reorganization under chapter 11 of the Bankruptcy Code. Since the Petition Date, the Debtors have continued in possession of their properties and, as debtors in possession, are authorized to operate and manage their respective businesses and enter into all transactions (including obtaining services, supplies and inventories) that each could have entered into in the ordinary course of their business had there been no bankruptcy. Although each Debtor is authorized to operate its business as a debtor in possession, it may not engage in transactions outside the ordinary course of business without first complying with the notice and hearing provisions of the Bankruptcy Code and obtaining Bankruptcy Court approval when necessary. As debtors in possession, the Debtors have the right, subject to the approval of the Bankruptcy Court, under the relevant provisions of the Bankruptcy Code, to assume or reject executory contracts and unexpired leases, including real property leases. Certain parties to such executory contracts and unexpired leases with the Company, including parties to such real property leases, may file motions with the Bankruptcy Court seeking to require the Company to assume or reject those contracts or leases. In this context, "assumption" requires that the Company cure, or provide adequate assurance that it will cure, all existing defaults under the contract or lease and provide adequate assurance of future performance under relevant provisions of the Bankruptcy Code; and "rejection" means that the Company is relieved from its obligations to perform further under the contract or lease. Rejection of an executory contract or lease may constitute a breach of that contract and may afford the non-debtor party the right to assert a claim against the bankruptcy estate for damages arising out of the breach, which claim shall be allowed or disallowed as if such claim had 36 39 arisen before the date of the filing of the petition. By order of the Bankruptcy Court, effective February 5, 1996, the Company obtained an extension of time within which to assume or reject its non-residential real property leases through and including the confirmation date of its plan of reorganization, except for certain leases on non-residential real property and certain objecting landlords for which the time within which such leases must be assumed or rejected was extended to September 30, 1996. Since the Petition Date, the Company has rejected 142 retail store leases. Prepetition claims that were contingent, unliquidated, or disputed as of the commencement of the Company's chapter 11 cases, including, without limitation, those that arise in connection with rejection of executory contracts or unexpired leases, may be allowed or disallowed depending on the nature of the claim. Such claims may be fixed by the Bankruptcy Court or otherwise settled or agreed upon by the parties. As a general matter, the treatment of claims pending in the Bankruptcy Court will be determined as part of the formulation and confirmation of a plan of reorganization. Described below are two adversary proceedings now pending in the Bankruptcy Court. On January 24, 1996, Wells Fargo Bank, N.A., individually and as agent for itself and Union Bank (collectively, "Wells"), commenced an adversary proceeding in the Bankruptcy Court, Adversary Proceeding No. 96-1100, against the Debtors claiming that a tax refund, estimated to be approximately $9.3 million (the "Tax Refund"), which the Company anticipates receiving in respect of Fiscal 1995, is subject to Wells' prepetition lien on certain of the Company's assets. Wells also requested the entry of a Temporary Restraining Order ("TRO") directing the Company to segregate the proceeds of the Tax Refund (which are not expected to be received prior to May 1996) pending a trial and entry of a judgment in this adversary proceeding. The Company disputes Wells' claims. The parties to the adversary proceeding entered into a stipulation settling Wells' request for the TRO and setting a briefing and discovery schedule in the adversary proceeding. The trial is presently scheduled for June 3, 1996. On January 5, 1996, the Company commenced an adversary proceeding in the Bankruptcy Court against Wells, Adversary Proceeding No. 96-01017. Wells asserts that it has a lien on certain credit card receivables and in a deposit account estimated to be in the aggregate amount of approximately $2.5 million. The Company instituted this proceeding to obtain a judicial determination and declaration that Wells does not hold a valid and perfected security interest in the credit card receivables or the deposit account or, alternatively, that the security interest, if any, held by Wells in such property can be avoided. To the best of management's knowledge, there are no other material pending legal proceedings. The Company is, however, subject to other legal proceedings and claims which have arisen in the ordinary course of its business. - -------------------------------------------------------------------------------- NOTE L OTHER ACCRUED LIABILITIES Other accrued liabilities are summarized as follows:
As of As of January 27, 1996 January 28, 1995 ---------------- ---------------- Deferred rent $ 1,771,680 $ 1,712,155 Other 6,606,625 18,465,199 ----------- ----------- $ 8,378,305 $20,177,354 =========== ===========
37 40 REPORT OF INDEPENDENT AUDITORS The Board of Directors The Clothestime, Inc.: We have audited the accompanying consolidated balance sheets of The Clothestime, Inc. and subsidiaries as of January 27, 1996 and January 28, 1995, and the related consolidated statements of operations, shareholders' equity and cash flows for each of the years in the three-year period ended January 27, 1996. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of The Clothestime, Inc. and subsidiaries as of January 27, 1996 and January 28, 1995 and the results of their operations and their cash flows for each of the years in the three-year period ended January 27, 1996, in conformity with generally accepted accounting principles. The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note A, The Clothestime, Inc. and certain of its subsidiaries (collectively, the "Debtors") commenced reorganization cases by filing voluntary petitions for relief under chapter 11 of the United States Bankruptcy Code in the United States Bankruptcy Court for the Central District of California (the "Bankruptcy Court") on December 8, 1995. The Debtors are currently operating their respective businesses as debtors-in-possession under the jurisdiction of the Bankruptcy Court and continuation of The Clothestime, Inc. and its subsidiaries as a going concern is contingent upon, among other things, the ability to (1) formulate an acceptable plan of reorganization that will be confirmed by the Bankruptcy Court, (2) achieve satisfactory levels of profitable operations and (3) maintain compliance with the debtor-in-possession financing and generate adequate sources of other liquidity, as described in Note A to the consolidated financial statements. These contingencies and the uncertainties inherent in the bankruptcy process raise substantial doubt about the ability of The Clothestime, Inc. and its subsidiaries to continue as a going concern. The consolidated financial statements do not include any adjustments that might result from the outcome of these uncertainties. KPMG PEAT MARWICK LLP Orange County, California April 4, 1996 38 41 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The information set forth under the captions "ELECTION OF DIRECTORS" and "TRANSACTIONS WITH MANAGEMENT AND OTHERS - Compliance with Section 16(a) of the Exchange Act" in the Company's definitive proxy statement (the "Proxy Statement") for the Annual Meeting scheduled to be held on June 14, 1996 is incorporated herein by reference. The Proxy Statement will be filed with the Commission not later than 120 days after the close of Fiscal 1995. Information regarding the Company's executive officers is included in Part I of this Annual Report on Form 10-K under the caption "EXECUTIVE OFFICERS OF THE REGISTRANT." ITEM 11. EXECUTIVE COMPENSATION Except as specifically provided herein, the information set forth under the captions "COMPENSATION OF EXECUTIVE OFFICERS" and "INFORMATION ABOUT THE BOARD OF DIRECTORS AND COMMITTEES OF THE BOARD - Compensation of Directors" in the Proxy Statement is incorporated herein by reference. The Report of the Compensation Committee on Executive Compensation and the Performance Graph set forth under the caption "COMPENSATION OF EXECUTIVE OFFICERS" shall not be deemed incorporated by reference in this Annual Report on Form 10-K and shall not otherwise be deemed "filed" as part of this Annual Report on Form 10-K. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information set forth under the caption "SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT" in the Proxy Statement is incorporated herein by reference. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information set forth under the caption "TRANSACTIONS WITH MANAGEMENT AND OTHERS" in the Proxy Statement is incorporated herein by reference. 39 42 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (a) Financial documents, schedules and exhibits filed as part of this report: INDEX TO FINANCIAL STATEMENTS AND SCHEDULES (1) FINANCIAL STATEMENTS. The following consolidated financial statements of the Company, together with the related notes to consolidated financial statements and the report of independent auditors, are included in Item 8 of this report. Page number references are to this report. PAGE ---- Financial Statements and Notes thereto: Consolidated Balance Sheets - as of January 27, 1996 and January 28, 1995. 24 Consolidated Statements of Operations - Years Ended January 27, 1996, January 28, 1995 and January 29, 1994. 25 Consolidated Statements of Shareholders' Equity - Years Ended January 27, 1996, January 28, 1995 and January 29, 1994. 26 Consolidated Statements of Cash Flows - Years Ended January 27, 1996, January 28, 1995 and January 29, 1994. 27 Notes to Consolidated Financial Statements 28 Report of Independent Auditors 38 (2) FINANCIAL STATEMENT SCHEDULES. Schedules are omitted since they are not applicable, not required or the information required to be set forth therein is included in the financial statements or in the notes thereto. (3) EXHIBITS. The Exhibits listed below (to the extent not incorporated by reference as an exhibit) are filed with this annual report on Form 10-K. 40 43 Exhibit No. - ----------- 3.1 Certificate of Incorporation of The Clothestime, Inc., a Stock corporation, certified by the Delaware Secretary of State on April 30, 1991, previously filed as Exhibit 3.1 to the Company's Current Report on Form 8-K dated June 20, 1991, filed with the Commission on August 5, 1991 (File No. 0-12203) (the "June 20, 1991 Current Report"), which is incorporated herein by reference. 3.2 Bylaws of The Clothestime, Inc., as currently in effect, previously filed as Exhibit 3.2 to the June 20, 1991 Current Report, which is incorporated herein by reference. 4.1 Rights Agreement, dated as of March 27, 1992, by and between The Clothestime, Inc. and Harris Trust Company of California, previously filed as Exhibit 4.1 to the Company's Current Report on Form 8-K dated March 27, 1992 filed with the Commission on March 30, 1992 (File No. 0-12203), which is incorporated herein by reference. Material Contracts Relating to Management Compensation Plans or Arrangements. 10.1 The Clothestime, Inc. 1983-84 Stock Option Plan, previously filed as Exhibit 4.1 to the Company's Post-Effective Amendment No. 2 to Registration Statement No. 2-90248 on Form S-8, filed with the Commission on October 24, 1991, which is incorporated herein by reference. 10.2 The Clothestime, Inc. 1984-85 Stock Option Plan, previously filed as Exhibit 4.1 to the Company's Post-Effective Amendment No. 1 to Registration Statement No. 2-92111 on Form S-8, filed with the Commission on October 24, 1991, which is incorporated herein by reference. 10.3 The Clothestime, Inc. 1985-86 Stock Option Plan, previously filed as Exhibit 4.1 to the Company's Post-Effective Amendment No. 1 to Registration Statement No. 33-3304 on Form S-8, filed with the Commission on October 24, 1991, which is incorporated herein by reference. 10.4 The Clothestime, Inc. 1987-88 Stock Option Plan, as amended and restated, previously filed as Exhibit 10.4 to the Company's Annual Report on Form 10- K for the fiscal year ended January 29, 1994 (File No. 0-12203) (the "1993 Annual Report"), which is incorporated herein by reference. 10.5 The Clothestime, Inc. Founders' Stock Option Plan, as amended and restated, previously filed as Exhibit 10.5 to the 1993 Annual Report, which is incorporated herein by reference. 41 44 Exhibit No. - ----------- 10.6 The Clothestime, Inc. Second Founders' Stock Option Plan, as amended and restated, previously filed as Exhibit 10.6 to the 1993 Annual Report, which is incorporated herein by reference. 10.7 The Clothestime, Inc. 1991 Stock Option Plan, as amended and restated, previously filed as Exhibit 4.1 to the Company's Registration Statement No. 33-81432 on Form S-8, filed with the Commission on July 12, 1994, which is incorporated herein by reference. 10.8 The Clothestime, Inc. Nonqualified Stock Option Plan for Non-Employee Directors, as amended, previously filed as Exhibit 10.8 to the Company's Annual Report on Form 10-K for the fiscal year ended January 28, 1995 (File No. 0-12203) (the "1994 Annual Report"), which is incorporated herein by reference. 10.9 The 1995 Management Incentive Bonus Program. 10.10 The 1995 Incentive MBO Bonus Plan. 10.11 The Clothestime, Inc. Associates Savings and Investment Plan, as amended and restated, previously filed as Exhibit 10.18 to the 1993 Annual Report, which is incorporated herein by reference. 10.12 The Executive Medical Reimbursement Program, previously filed as Exhibit 10.16 to the 1991 Annual Report, which is incorporated herein by reference. 10.13 Employment Agreement dated April 13, 1994 between the Company and Norman Abramson, previously filed as Exhibit 10.20 to the 1993 Annual Report, which is incorporated herein by reference. 10.14 Severance Agreement dated October 10, 1994 between the Company and David A. Sejpal, previously filed as Exhibit 10.16 to the 1994 Annual Report, which is incorporated herein by reference. 10.15 Settlement and Release Agreement dated January 6, 1995, as amended, between the Company and Raymond A. DeAngelo, previously filed as Exhibit 10.17 to the 1994 Annual Report, which is incorporated herein by reference. 10.16 Consulting Agreement dated January 6, 1995 between the Company and Raymond A. DeAngelo, previously filed as Exhibit 10.18 to the 1994 Annual Report, which is incorporated herein by reference. 10.17 Letter Agreement of Employment dated February 24, 1995 between the Company and Lynne Sperling, previously filed as Exhibit 10.19 to the 1994 Annual Report, which is incorporated herein by reference. 42 45 Exhibit No. - ----------- 10.18 Letter Agreement of Employment dated February 27, 1995 between the Company and Lynne Sperling, previously filed as Exhibit 10.20 to the 1994 Annual Report, which is incorporated herein by reference. Other Material Contracts 10.19 Standard Industrial Lease-Net dated March 25, 1988, between the Company and DeAngelo-Ortega Partnership No. 8 (included as part of this lease are the following related documents: Addendum to Lease dated March 25, 1988, between the Company and DeAngelo-Ortega Partnership No. 8; and Lease Modification and Option Agreement dated March 25, 1988, between the Company and DeAngelo-Ortega Partnership No. 8), previously filed as Exhibit 10.17 to the Company's Annual Report on Form 10-K for the fiscal year ended January 30, 1988, filed with the Commission on April 28, 1988 (File No. 0-12203) (the "1987 Annual Report"), which is incorporated herein by reference (5325 East Hunter Avenue, Anaheim, California). 10.20 First Amendment to Lease Modification and Option Agreement, dated September 20, 1989, between the Company and DeAngelo-Ortega Partnership No. 8, previously filed as Exhibit 10.15 to the Company's Annual Report on Form 10-K for the fiscal year ended January 27, 1990, filed with the Commission on April 27, 1990 (File No. 0-12203) (the "1989 Annual Report"), which is incorporated herein by reference. 10.21 Second Amendment to Lease Modification and Option Agreement, dated June 28, 1990, between the Company and DeAngelo-Ortega Partnership No. 8, previously filed as Exhibit 10.12 to the Company's Annual Report on Form 10-K for the fiscal year ended January 26, 1991 (File No. 0-12203), which is incorporated herein by reference. 10.22 Indemnification Agreement dated June 20, 1991 between the Company and Norman Abramson, previously filed as Exhibit 10.23 to the 1991 Annual Report, which is incorporated herein by reference. 10.23 Indemnification Agreement dated June 24, 1988 between the Company and Eric J. Boden, previously filed as Exhibit No. 10.18 to the Company's Annual Report on Form 10-K for the fiscal year ended January 28, 1989, filed with the Commission on April 26, 1989 (File No. 0-12203) (the "1988 Annual Report"), which is incorporated herein by reference. 10.24 Indemnification Agreement dated June 20, 1991 between the Company and Harvey A. Bookstein, previously filed as Exhibit 10.25 to the 1991 Annual Report, which is incorporated herein by reference. 43 46 Exhibit No. - ----------- 10.25 Indemnification Agreement dated June 24, 1988 between the Company and P. Bruce Cumming, previously filed as Exhibit No. 10.20 to the 1988 Annual Report, which is incorporated herein by reference. 10.26 Indemnification Agreement dated June 20, 1991 between the Company and Jeffrey R. Dake, previously filed as Exhibit 10.27 to the 1991 Annual Report, which is incorporated herein by reference. 10.27 Indemnification Agreement dated June 20, 1991 between the Company and August DeAngelo, previously filed as Exhibit 10.28 to the 1991 Annual Report, which is incorporated herein by reference. 10.28 Indemnification Agreement dated June 20, 1991 between the Company and Michael P. DeAngelo, previously filed as Exhibit 10.29 to the 1991 Annual Report, which is incorporated herein by reference. 10.29 Indemnification Agreement dated June 20, 1991 between the Company and Raymond A. DeAngelo, previously filed as Exhibit 10.30 to the 1991 Annual Report, which is incorporated herein by reference. 10.30 Indemnification Agreement dated December 19, 1992 between the Company and Herman D. Epstein, previously filed as Exhibit 10.34 to the 1993 Annual Report, which is incorporated herein by reference. 10.31 Indemnification Agreement dated June 20, 1991 between the Company and Mallory Factor, previously filed as Exhibit 10.31 to the 1991 Annual Report, which is incorporated herein by reference. 10.32 Indemnification Agreement dated June 20, 1991 between the Company and George Foos, previously filed as Exhibit 10.32 to the 1991 Annual Report, which is incorporated herein by reference. 10.33 Indemnification Agreement dated July 15, 1991 between the Company and Barry Grosser, previously filed as Exhibit 10.33 to the 1991 Annual Report, which is incorporated herein by reference. 10.34 Indemnification Agreement dated June 20, 1991 between the Company and John Ortega II, previously filed as Exhibit 10.35 to the 1991 Annual Report, which is incorporated herein by reference. 10.35 Indemnification Agreement dated June 20, 1991 between the Company and Douglas L. Pereira, previously filed as Exhibit 10.36 to the 1991 Annual Report, which is incorporated herein by reference. 44 47 Exhibit No. - ----------- 10.36 Indemnification Agreement dated June 20, 1991 between the Company and David A. Sejpal, previously filed as Exhibit 10.37 to the 1991 Annual Report, which is incorporated herein by reference. 10.37 Indemnification Agreement dated as of March 1, 1995 between the Company and Lynne Sperling, previously filed as Exhibit No. 10.41 to the 1994 Annual Report, which is incorporated herein by reference. 10.38 Indemnification Agreement dated September 22, 1995 between the Company and Charles Castaneda. 10.39 Master Lease Purchase Agreement, dated April 29, 1993 between Metlife Capital Corporation, as Lessor, and the Company, as Lessee relating to Point of Sale Equipment and Scanners, previously filed as Exhibit 10.44 to the 1993 Annual Report, which is incorporated herein by reference. 10.40 Lease Agreement, dated December 11, 1990, between Matrix Funding Corporation, who subsequently assigned all of its right, title and interest under the Lease to General Electric Capital Corporation, as Lessor, and the Company, as Lessee, together with (i) Schedule No. 1 to Lease Agreement, dated December 11, 1990 and amended March 6, 1992 and August 19, 1993, and related Sale and Leaseback Agreement dated December 11, 1990; (ii) Schedule No. 2 to Lease Agreement, dated March 22, 1991 and amended March 6, 1992 and August 19, 1993, and related Sale and Leaseback Agreement dated March 22, 1991; (iii) Schedule No. 3 to Lease Agreement, dated March 16, 1992 and amended March 16, 1992 and August 19, 1993 and related Sale and Leaseback Agreement; and (iv) Schedule No. 4 dated August 20, 1993, and related Sale and Leaseback Agreement, relating to Point of Sale Equipment and Scanners and IBM 'LIC' DiskArray Subsystems with 970 ME Disk Drives, previously filed as Exhibit 10.45 to the 1993 Annual Report, which is incorporated herein by reference. 10.41 Credit Agreement dated February 28, 1995 between Clothestime Stores, Inc., Wells Fargo Bank, N.A. and Union Bank, previously filed as Exhibit 10.45 to the 1994 Annual Report, which is incorporated herein by reference. 10.42 Waiver and Amendment Agreement dated April 27, 1995 by and among the Company, each of the subsidiaries of the Company, Wells Fargo Bank, N.A. and Union Bank, previously filed as Exhibit 10.46 to the 1994 Annual Report, which is incorporated herein by reference. 10.43 Security Agreement dated February 28, 1995 between the Company and Wells Fargo Bank, N.A., previously filed as Exhibit 10.47 to the 1994 Annual Report, which is incorporated herein by reference. A Schedule attached to the previously filed Exhibit 10.47 identifies additional parties to separate Security 45 48 Exhibit No. - ----------- Agreements dated February 28, 1995 with Wells Fargo Bank, N.A., each of which is substantially identical in all material respects to the Security Agreement filed as Exhibit 10.47. 10.44 Guaranty dated February 28, 1995 between the Company and Wells Fargo Bank, N.A., previously filed as Exhibit 10.48 to the 1994 Annual Report, which is incorporated herein by reference. A Schedule attached to the previously filed Exhibit 10.48 identifies additional parties to separate Guaranties dated February 28, 1995 with Wells Fargo Bank, N.A., each of which is substantially identical in all material respects to the Guaranty filed as Exhibit 10.48. 10.45 Pledge Agreement dated February 28, 1995 between Clothestime Stores, Inc. and Wells Fargo Bank, N.A., previously filed as Exhibit 10.49 to the 1994 Annual Report, which is incorporated herein by reference. A Schedule attached to the previously filed Exhibit 10.49 identifies additional parties to separate Pledge Agreements dated February 28, 1995 with Wells Fargo Bank, N.A., each of which is substantially identical in all material respects to the Pledge Agreement filed as Exhibit 10.49. 10.46 Warrant Agreement dated February 28, 1995 between the Company and Wells Fargo Bank, previously filed as Exhibit 10.50 to the 1994 Annual Report, which is incorporated herein by reference. 10.47 Warrant Agreement dated February 28, 1995 between the Company and Union Bank, previously filed as Exhibit 10.51 to the 1994 Annual Report, which is incorporated herein by reference. 10.48 Deed of Trust, Assignment of Rents, Security Agreement and Fixture Filing dated February 28, 1995 between Clothestime Stores, Inc., American Securities Company and Wells Fargo Bank, N.A., previously filed as Exhibit 10.52 to the 1994 Annual Report, which is incorporated herein by reference. 10.49 $1.4 Million Loan Agreement dated February 28, 1995 between Clothestime Stores, Inc. and Wells Fargo Bank, N.A., previously filed as Exhibit 10.53 to the 1994 Annual Report, which is incorporated herein by reference. 10.50 Guaranty dated February 28, 1995 between the Company and Wells Fargo Bank, N.A., previously filed as Exhibit 10.54 to the 1994 Annual Report, which is incorporated herein by reference. A Schedule attached to the previously filed Exhibit 10.54 identifies additional parties to separate Guaranties dated February 28, 1995 with Wells Fargo Bank, N.A., each of which is substantially identical in all material respects to the Guaranty filed as Exhibit 10.54. 46 49 Exhibit No. - ----------- 10.51 Deed of Trust with Assignment of Rents dated as of February 28, 1995 between Clothestime Stores, Inc., American Securities Company and Wells Fargo Bank, N.A., previously filed as Exhibit 10.55 to the 1994 Annual Report, which his incorporated herein by reference. 10.52 Standard Industrial Lease-Net dated July 8, 1986, as amended, between the Company and Russell Berrie, previously filed as Exhibit 10.56 to the 1994 Annual Report, which is incorporated herein by reference (5330 East Hunter Avenue, Anaheim, California). 10.53 Master Lease Agreement dated November 16, 1994, as amended, between Clothestime Stores, Inc. and USL Capital Corporation, previously filed as Exhibit 10.57 to the 1994 Annual Report, which is incorporated herein by reference. 10.54 Guaranty dated November 17, 1994 between the Company and USL Capital Corporation, previously filed as Exhibit 10.58 to the 1994 Annual Report, which is incorporated herein by reference. 10.55 Financing Agreement dated December 28, 1995 by and among The CIT Group/Business Credit, Inc., as lender, and Clothestime Stores, Inc., as borrower, and the Company, MRJ Industries, Inc., Clothestime Investment, Inc., Clothestime International, Inc. and Clothestime Acquisition Corporation, as guarantors. 10.56 Guaranty dated December 28, 1995 made by the Company, MRJ Industries, Inc., Clothestime Investment, Inc., Clothestime International, Inc. and Clothestime Acquisition Corporation in favor of The CIT Group/Business Credit, Inc. 21 Subsidiaries of The Clothestime, Inc. 23 Consent of KPMG Peat Marwick LLP, independent certified public accountants. 27 Financial Data Schedule. (b) Reports on Form 8-K During the fourth quarter of the fiscal year covered by this Form 10-K, the Company filed with the Securities and Exchange Commission a Current Report on Form 8-K dated December 8, 1995 (the "Form 8-K") disclosing under "Item 3. Bankruptcy or Receivership" the fact that on December 8, 1995, the Company and five of its subsidiaries, Clothestime Stores, Inc., MRJ Industries, Inc., Clothestime Acquisition Corporation, Clothestime Investment, Inc. and Clothestime International, Inc., filed petitions in the United States Bankruptcy Court for the Central District of California, Santa Ana Division, Jointly Administered Case No. SA95- 47 50 Exhibit No. - ----------- 22533JW, assigned to Judge John J. Wilson, seeking reorganization under chapter 11 of the Federal Bankruptcy Code. 48 51 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. THE CLOTHESTIME, INC. Date: April 26, 1996 By: /s/ John Ortega II ------------------------- John Ortega II Chairman of the Board and Chief Executive Officer POWER OF ATTORNEY KNOW ALL MEN BY THESE PRESENTS, that such person whose signature appears below constitutes and appoints John Ortega II and David A. Sejpal, and each of them his true and lawful attorneys-in-fact and agents, with full power of substitution and resubstitution, for him and in his name, place and stead, in any and all capacities, to sign any and all amendments to this Form 10-K and to file the same, with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite and necessary to be done in and about the premises, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents, or any of them, or their or his substitute or substitutes, may lawfully do or cause to be done by virtue hereof. 49 52 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
NAME CAPACITY DATE /s/ John Ortega II Director, Chairman of the Board April 26, 1996 - ----------------------------- and Chief Executive Officer John Ortega II (Principal Executive Officer) /s/ Norman Abramson Director, President and Chief April 26, 1996 - ----------------------------- Operating Officer Norman Abramson /s/ Herman D. Epstein Director April 26, 1996 - ----------------------------- Herman D. Epstein /s/ George Foos Director April 26, 1996 - ----------------------------- George Foos /s/ David A. Sejpal Director, Vice President and April 26, 1996 - ----------------------------- Chief Financial Officer (Principal David A. Sejpal Financial Officer) /s/ Douglas L. Pereira Controller (Principal Accounting April 26, 1996 - ----------------------------- Officer) Douglas L. Pereira
50 53 EXHIBIT INDEX Exhibit No. - ----------- 3.1 Certificate of Incorporation of The Clothestime, Inc., a Stock corporation, certified by the Delaware Secretary of State on April 30, 1991, previously filed as Exhibit 3.1 to the Company's Current Report on Form 8-K dated June 20, 1991, filed with the Commission on August 5, 1991 (File No. 0-12203) (the "June 20, 1991 Current Report"), which is incorporated herein by reference. 3.2 Bylaws of The Clothestime, Inc., as currently in effect, previously filed as Exhibit 3.2 to the June 20, 1991 Current Report, which is incorporated herein by reference. 4.1 Rights Agreement, dated as of March 27, 1992, by and between The Clothestime, Inc. and Harris Trust Company of California, previously filed as Exhibit 4.1 to the Company's Current Report on Form 8-K dated March 27, 1992 filed with the Commission on March 30, 1992 (File No. 0-12203), which is incorporated herein by reference. Material Contracts Relating to Management Compensation Plans or Arrangements. 10.1 The Clothestime, Inc. 1983-84 Stock Option Plan, previously filed as Exhibit 4.1 to the Company's Post-Effective Amendment No. 2 to Registration Statement No. 2-90248 on Form S-8, filed with the Commission on October 24, 1991, which is incorporated herein by reference. 10.2 The Clothestime, Inc. 1984-85 Stock Option Plan, previously filed as Exhibit 4.1 to the Company's Post-Effective Amendment No. 1 to Registration Statement No. 2-92111 on Form S-8, filed with the Commission on October 24, 1991, which is incorporated herein by reference. 10.3 The Clothestime, Inc. 1985-86 Stock Option Plan, previously filed as Exhibit 4.1 to the Company's Post-Effective Amendment No. 1 to Registration Statement No. 33-3304 on Form S-8, filed with the Commission on October 24, 1991, which is incorporated herein by reference. 10.4 The Clothestime, Inc. 1987-88 Stock Option Plan, as amended and restated, previously filed as Exhibit 10.4 to the Company's Annual Report on Form 10- K for the fiscal year ended January 29, 1994 (File No. 0-12203) (the "1993 Annual Report"), which is incorporated herein by reference. 10.5 The Clothestime, Inc. Founders' Stock Option Plan, as amended and restated, previously filed as Exhibit 10.5 to the 1993 Annual Report, which is incorporated herein by reference. 54 Exhibit No. - ----------- 10.6 The Clothestime, Inc. Second Founders' Stock Option Plan, as amended and restated, previously filed as Exhibit 10.6 to the 1993 Annual Report, which is incorporated herein by reference. 10.7 The Clothestime, Inc. 1991 Stock Option Plan, as amended and restated, previously filed as Exhibit 4.1 to the Company's Registration Statement No. 33-81432 on Form S-8, filed with the Commission on July 12, 1994, which is incorporated herein by reference. 10.8 The Clothestime, Inc. Nonqualified Stock Option Plan for Non-Employee Directors, as amended, previously filed as Exhibit 10.8 to the Company's Annual Report on Form 10-K for the fiscal year ended January 28, 1995 (File No. 0-12203) (the "1994 Annual Report"), which is incorporated herein by reference. 10.9 The 1995 Management Incentive Bonus Program. 10.10 The 1995 Incentive MBO Bonus Plan. 10.11 The Clothestime, Inc. Associates Savings and Investment Plan, as amended and restated, previously filed as Exhibit 10.18 to the 1993 Annual Report, which is incorporated herein by reference. 10.12 The Executive Medical Reimbursement Program, previously filed as Exhibit 10.16 to the 1991 Annual Report, which is incorporated herein by reference. 10.13 Employment Agreement dated April 13, 1994 between the Company and Norman Abramson, previously filed as Exhibit 10.20 to the 1993 Annual Report, which is incorporated herein by reference. 10.14 Severance Agreement dated October 10, 1994 between the Company and David A. Sejpal, previously filed as Exhibit 10.16 to the 1994 Annual Report, which is incorporated herein by reference. 10.15 Settlement and Release Agreement dated January 6, 1995, as amended, between the Company and Raymond A. DeAngelo, previously filed as Exhibit 10.17 to the 1994 Annual Report, which is incorporated herein by reference. 10.16 Consulting Agreement dated January 6, 1995 between the Company and Raymond A. DeAngelo, previously filed as Exhibit 10.18 to the 1994 Annual Report, which is incorporated herein by reference. 10.17 Letter Agreement of Employment dated February 24, 1995 between the Company and Lynne Sperling, previously filed as Exhibit 10.19 to the 1994 Annual Report, which is incorporated herein by reference. 55 Exhibit No. - ----------- 10.18 Letter Agreement of Employment dated February 27, 1995 between the Company and Lynne Sperling, previously filed as Exhibit 10.20 to the 1994 Annual Report, which is incorporated herein by reference. Other Material Contracts 10.19 Standard Industrial Lease-Net dated March 25, 1988, between the Company and DeAngelo-Ortega Partnership No. 8 (included as part of this lease are the following related documents: Addendum to Lease dated March 25, 1988, between the Company and DeAngelo-Ortega Partnership No. 8; and Lease Modification and Option Agreement dated March 25, 1988, between the Company and DeAngelo-Ortega Partnership No. 8), previously filed as Exhibit 10.17 to the Company's Annual Report on Form 10-K for the fiscal year ended January 30, 1988, filed with the Commission on April 28, 1988 (File No. 0-12203) (the "1987 Annual Report"), which is incorporated herein by reference (5325 East Hunter Avenue, Anaheim, California). 10.20 First Amendment to Lease Modification and Option Agreement, dated September 20, 1989, between the Company and DeAngelo-Ortega Partnership No. 8, previously filed as Exhibit 10.15 to the Company's Annual Report on Form 10-K for the fiscal year ended January 27, 1990, filed with the Commission on April 27, 1990 (File No. 0-12203) (the "1989 Annual Report"), which is incorporated herein by reference. 10.21 Second Amendment to Lease Modification and Option Agreement, dated June 28, 1990, between the Company and DeAngelo-Ortega Partnership No. 8, previously filed as Exhibit 10.12 to the Company's Annual Report on Form 10-K for the fiscal year ended January 26, 1991 (File No. 0-12203), which is incorporated herein by reference. 10.22 Indemnification Agreement dated June 20, 1991 between the Company and Norman Abramson, previously filed as Exhibit 10.23 to the 1991 Annual Report, which is incorporated herein by reference. 10.23 Indemnification Agreement dated June 24, 1988 between the Company and Eric J. Boden, previously filed as Exhibit No. 10.18 to the Company's Annual Report on Form 10-K for the fiscal year ended January 28, 1989, filed with the Commission on April 26, 1989 (File No. 0-12203) (the "1988 Annual Report"), which is incorporated herein by reference. 10.24 Indemnification Agreement dated June 20, 1991 between the Company and Harvey A. Bookstein, previously filed as Exhibit 10.25 to the 1991 Annual Report, which is incorporated herein by reference. 56 Exhibit No. - ----------- 10.25 Indemnification Agreement dated June 24, 1988 between the Company and P. Bruce Cumming, previously filed as Exhibit No. 10.20 to the 1988 Annual Report, which is incorporated herein by reference. 10.26 Indemnification Agreement dated June 20, 1991 between the Company and Jeffrey R. Dake, previously filed as Exhibit 10.27 to the 1991 Annual Report, which is incorporated herein by reference. 10.27 Indemnification Agreement dated June 20, 1991 between the Company and August DeAngelo, previously filed as Exhibit 10.28 to the 1991 Annual Report, which is incorporated herein by reference. 10.28 Indemnification Agreement dated June 20, 1991 between the Company and Michael P. DeAngelo, previously filed as Exhibit 10.29 to the 1991 Annual Report, which is incorporated herein by reference. 10.29 Indemnification Agreement dated June 20, 1991 between the Company and Raymond A. DeAngelo, previously filed as Exhibit 10.30 to the 1991 Annual Report, which is incorporated herein by reference. 10.30 Indemnification Agreement dated December 19, 1992 between the Company and Herman D. Epstein, previously filed as Exhibit 10.34 to the 1993 Annual Report, which is incorporated herein by reference. 10.31 Indemnification Agreement dated June 20, 1991 between the Company and Mallory Factor, previously filed as Exhibit 10.31 to the 1991 Annual Report, which is incorporated herein by reference. 10.32 Indemnification Agreement dated June 20, 1991 between the Company and George Foos, previously filed as Exhibit 10.32 to the 1991 Annual Report, which is incorporated herein by reference. 10.33 Indemnification Agreement dated July 15, 1991 between the Company and Barry Grosser, previously filed as Exhibit 10.33 to the 1991 Annual Report, which is incorporated herein by reference. 10.34 Indemnification Agreement dated June 20, 1991 between the Company and John Ortega II, previously filed as Exhibit 10.35 to the 1991 Annual Report, which is incorporated herein by reference. 10.35 Indemnification Agreement dated June 20, 1991 between the Company and Douglas L. Pereira, previously filed as Exhibit 10.36 to the 1991 Annual Report, which is incorporated herein by reference. 57 Exhibit No. - ----------- 10.36 Indemnification Agreement dated June 20, 1991 between the Company and David A. Sejpal, previously filed as Exhibit 10.37 to the 1991 Annual Report, which is incorporated herein by reference. 10.37 Indemnification Agreement dated as of March 1, 1995 between the Company and Lynne Sperling, previously filed as Exhibit No. 10.41 to the 1994 Annual Report, which is incorporated herein by reference. 10.38 Indemnification Agreement dated September 22, 1995 between the Company and Charles Castaneda. 10.39 Master Lease Purchase Agreement, dated April 29, 1993 between Metlife Capital Corporation, as Lessor, and the Company, as Lessee relating to Point of Sale Equipment and Scanners, previously filed as Exhibit 10.44 to the 1993 Annual Report, which is incorporated herein by reference. 10.40 Lease Agreement, dated December 11, 1990, between Matrix Funding Corporation, who subsequently assigned all of its right, title and interest under the Lease to General Electric Capital Corporation, as Lessor, and the Company, as Lessee, together with (i) Schedule No. 1 to Lease Agreement, dated December 11, 1990 and amended March 6, 1992 and August 19, 1993, and related Sale and Leaseback Agreement dated December 11, 1990; (ii) Schedule No. 2 to Lease Agreement, dated March 22, 1991 and amended March 6, 1992 and August 19, 1993, and related Sale and Leaseback Agreement dated March 22, 1991; (iii) Schedule No. 3 to Lease Agreement, dated March 16, 1992 and amended March 16, 1992 and August 19, 1993 and related Sale and Leaseback Agreement; and (iv) Schedule No. 4 dated August 20, 1993, and related Sale and Leaseback Agreement, relating to Point of Sale Equipment and Scanners and IBM 'LIC' DiskArray Subsystems with 970 ME Disk Drives, previously filed as Exhibit 10.45 to the 1993 Annual Report, which is incorporated herein by reference. 10.41 Credit Agreement dated February 28, 1995 between Clothestime Stores, Inc., Wells Fargo Bank, N.A. and Union Bank, previously filed as Exhibit 10.45 to the 1994 Annual Report, which is incorporated herein by reference. 10.42 Waiver and Amendment Agreement dated April 27, 1995 by and among the Company, each of the subsidiaries of the Company, Wells Fargo Bank, N.A. and Union Bank, previously filed as Exhibit 10.46 to the 1994 Annual Report, which is incorporated herein by reference. 10.43 Security Agreement dated February 28, 1995 between the Company and Wells Fargo Bank, N.A., previously filed as Exhibit 10.47 to the 1994 Annual Report, which is incorporated herein by reference. A Schedule attached to the previously filed Exhibit 10.47 identifies additional parties to separate Security 58 Exhibit No. - ----------- Agreements dated February 28, 1995 with Wells Fargo Bank, N.A., each of which is substantially identical in all material respects to the Security Agreement filed as Exhibit 10.47. 10.44 Guaranty dated February 28, 1995 between the Company and Wells Fargo Bank, N.A., previously filed as Exhibit 10.48 to the 1994 Annual Report, which is incorporated herein by reference. A Schedule attached to the previously filed Exhibit 10.48 identifies additional parties to separate Guaranties dated February 28, 1995 with Wells Fargo Bank, N.A., each of which is substantially identical in all material respects to the Guaranty filed as Exhibit 10.48. 10.45 Pledge Agreement dated February 28, 1995 between Clothestime Stores, Inc. and Wells Fargo Bank, N.A., previously filed as Exhibit 10.49 to the 1994 Annual Report, which is incorporated herein by reference. A Schedule attached to the previously filed Exhibit 10.49 identifies additional parties to separate Pledge Agreements dated February 28, 1995 with Wells Fargo Bank, N.A., each of which is substantially identical in all material respects to the Pledge Agreement filed as Exhibit 10.49. 10.46 Warrant Agreement dated February 28, 1995 between the Company and Wells Fargo Bank, previously filed as Exhibit 10.50 to the 1994 Annual Report, which is incorporated herein by reference. 10.47 Warrant Agreement dated February 28, 1995 between the Company and Union Bank, previously filed as Exhibit 10.51 to the 1994 Annual Report, which is incorporated herein by reference. 10.48 Deed of Trust, Assignment of Rents, Security Agreement and Fixture Filing dated February 28, 1995 between Clothestime Stores, Inc., American Securities Company and Wells Fargo Bank, N.A., previously filed as Exhibit 10.52 to the 1994 Annual Report, which is incorporated herein by reference. 10.49 $1.4 Million Loan Agreement dated February 28, 1995 between Clothestime Stores, Inc. and Wells Fargo Bank, N.A., previously filed as Exhibit 10.53 to the 1994 Annual Report, which is incorporated herein by reference. 10.50 Guaranty dated February 28, 1995 between the Company and Wells Fargo Bank, N.A., previously filed as Exhibit 10.54 to the 1994 Annual Report, which is incorporated herein by reference. A Schedule attached to the previously filed Exhibit 10.54 identifies additional parties to separate Guaranties dated February 28, 1995 with Wells Fargo Bank, N.A., each of which is substantially identical in all material respects to the Guaranty filed as Exhibit 10.54. 59 Exhibit No. - ----------- 10.51 Deed of Trust with Assignment of Rents dated as of February 28, 1995 between Clothestime Stores, Inc., American Securities Company and Wells Fargo Bank, N.A., previously filed as Exhibit 10.55 to the 1994 Annual Report, which his incorporated herein by reference. 10.52 Standard Industrial Lease-Net dated July 8, 1986, as amended, between the Company and Russell Berrie, previously filed as Exhibit 10.56 to the 1994 Annual Report, which is incorporated herein by reference (5330 East Hunter Avenue, Anaheim, California). 10.53 Master Lease Agreement dated November 16, 1994, as amended, between Clothestime Stores, Inc. and USL Capital Corporation, previously filed as Exhibit 10.57 to the 1994 Annual Report, which is incorporated herein by reference. 10.54 Guaranty dated November 17, 1994 between the Company and USL Capital Corporation, previously filed as Exhibit 10.58 to the 1994 Annual Report, which is incorporated herein by reference. 10.55 Financing Agreement dated December 28, 1995 by and among The CIT Group/Business Credit, Inc., as lender, and Clothestime Stores, Inc., as borrower, and the Company, MRJ Industries, Inc., Clothestime Investment, Inc., Clothestime International, Inc. and Clothestime Acquisition Corporation, as guarantors. 10.56 Guaranty dated December 28, 1995 made by the Company, MRJ Industries, Inc., Clothestime Investment, Inc., Clothestime International, Inc. and Clothestime Acquisition Corporation in favor of The CIT Group/Business Credit, Inc. 21 Subsidiaries of The Clothestime, Inc. 23 Consent of KPMG Peat Marwick LLP, independent certified public accountants. 27 Financial Data Schedule. (b) Reports on Form 8-K During the fourth quarter of the fiscal year covered by this Form 10-K, the Company filed with the Securities and Exchange Commission a Current Report on Form 8-K dated December 8, 1995 (the "Form 8-K") disclosing under "Item 3. Bankruptcy or Receivership" the fact that on December 8, 1995, the Company and five of its subsidiaries, Clothestime Stores, Inc., MRJ Industries, Inc., Clothestime Acquisition Corporation, Clothestime Investment, Inc. and Clothestime International, Inc., filed petitions in the United States Bankruptcy Court for the Central District of California, Santa Ana Division, Jointly Administered Case No. SA95- 60 Exhibit No. - ----------- 22533JW, assigned to Judge John J. Wilson, seeking reorganization under chapter 11 of the Federal Bankruptcy Code. EX-10.9 2 MANAGEMENT INCENTIVE COMPENSATION PROGRAM 1 EXHIBIT 10.9 MANAGEMENT INCENTIVE COMPENSATION PROGRAM During Fiscal 1995, the Compensation Committee of the Board of Directors by resolution established an incentive bonus program for Fiscal 1995 for the benefit of the Company's senior executives, vice presidents and senior managers. The bonus program had an incentive tiered structure which was established by applying a sliding scale percentage to predetermined ranges of the Company's net income in excess of certain amounts. Assuming certain threshold net income levels were met, the aggregate amount available under the bonus program would be approximately $3 million which would be allocated among five groups. Participants in each group were eligible to be awarded bonuses by applying the applicable sliding scale percentage to their base salaries (grossed-up for certain benefits). In addition, those vice presidents and senior managers who are evaluated under the Company's Management-By-Objective Program (the "MBO Program") could increase their bonuses (up to double such bonus) by attaining certain scores under the MBO Program. Due to the Company's net loss in Fiscal 1995, no participant in the incentive bonus program for Fiscal 1995 was awarded a bonus. EX-10.10 3 1995 MBO AND GROSS MARGIN INCENTIVE BONUS PROGRAM 1 EXHIBIT 10.10 1995 MBO AND GROSS MARGIN INCENTIVE BONUS PROGRAM During Fiscal 1995, the Compensation Committee of the Board of Directors by resolution established an incentive bonus program for Fiscal 1995 for the benefit of the Company's senior executives, vice presidents and senior managers. The incentive bonus program primarily focused on the attainment of high scores in the Company's Management-By-Objective Program (the "MBO Program"). Under the MBO Program, the Executive Committee of the Board of Directors (the "Executive Committee") assigns well defined individual objectives, depending on the respective position, to the MBO Program participants whose performance is then reviewed by the Executive Committee after the end of the fiscal year. Members of the Executive Committee do not participate in the MBO Program and, accordingly, did not participate in the incentive bonus program. Under the incentive bonus program, those MBO Program participants, other than certain designated buyers and merchants discussed below, who reached a threshold score in their MBO Program reviews were entitled to receive a bonus equal to 10% of their base salary. Also under the incentive bonus program, certain designated buyers and merchants (those whose performance of their job function can most directly impact sales) were entitled to receive (i) a bonus equal to 10% of their base salary if certain financial milestones were met during the fourth quarter of Fiscal 1995 and (ii) an additional bonus equal to 5% of their base salary if they attained a threshold score in their MBO Program review. Assuming all incentive bonus program participants met all of their respective goals during Fiscal 1995, the total liability to the Company would have been $544,000. No participant in the incentive bonus program for Fiscal 1995 was awarded a bonus. EX-10.38 4 INDEMNIFICATION AGREEMENT 1 EXHIBIT 10.38 INDEMNIFICATION AGREEMENT This Indemnification Agreement ("Agreement") is made as of this 22nd day of September, 1995 by and between THE CLOTHESTIME, INC., a Delaware corporation (the "Company"), and Charles Castaneda ("Indemnitee"). WHEREAS, Indemnitee is currently serving as Vice President, Merchandise Planning and Control of the Company and the parties wish Indemnitee to continue in such capacity. The Indemnitee is willing, subject to certain conditions including, without limitation, the execution and performance of this Agreement by the Company, to continue in that capacity; WHEREAS, in addition to the indemnification to which the Indemnitee is or may be entitled under the Certificate of Incorporation of the Company (the "Certificate") or the Bylaws of the company (the "Bylaws"), the Company has obtained at its sole expense insurance protecting its officers and directors including Indemnitee against certain losses arising out of actual or threatened actions, suits or proceedings to which such persons may be made or threatened to be made parties. However, as a result of circumstances having no relation to, and beyond the control of, the Company and Indemnitee, there can be no assurance of the continuation or renewal of the insurance; WHEREAS, the Company and Indemnitee recognize the increasing difficulty in obtaining directors' and officers' liability insurance, the significant increases in the cost of such insurance and the general reductions in the coverage of such insurance; WHEREAS, the Company and Indemnitee further recognize the substantial increase in corporate litigation in general, subjecting directors, officers, employees and other agents to expensive litigation risks; WHEREAS, the Company desires to attract and retain the services of highly qualified individuals, such as Indemnitee, to serve as directors, officers, employees and other agents of the Company; and WHEREAS, in recognition of Indemnitee's need for substantial protection against personal liability in order to enhance Indemnitee's continued and effective service to the Company, and in order to induce Indemnitee to provide services to the Company as an Executive Officer, the Company wishes to provide in this Agreement for the indemnification of and the advancing of expenses to Indemnitee to the fullest extent (whether partial or complete) permitted by law and as set forth in this Agreement, and, to the extent insurance is maintained, for the coverage of Indemnitee under the Company's directors' and officers' liability insurance policies. NOW, THEREFORE, in consideration of the above premises and of Indemnitee's promise to continue to serve the Company directly or, at its request, with another enterprise, and intending to be legally bound hereby, the parties agree as follows: 1. DEFINED TERMS AND CONSTRUCTION OF CERTAIN PHASES. As used in this Agreement: (a) "Board" shall mean the Board of Directors of the Company. 1 2 (b) References to the "Company" shall include, in addition to the resulting corporation, any constituent corporation (including any constituent of a constituent) absorbed in a consolidation or merger which, if its separate existence had continued, would have had power and authority to indemnify its directors, officers, employees or other agents, so that if Indemnitee is or was a director, officer, employee or other agent of such constituent corporation, or is or was serving at the request of such constituent corporation as a director, officer, employee or agent of another corporation, partnership, joint venture, trust or other enterprise, Indemnitee shall stand in the same position under the provisions of this Agreement with respect to the resulting or surviving corporation as Indemnitee would have with respect to such constituent corporation if its separate existence had continued. (c) A "Change in Control" shall be deemed to have occurred if (i) any "person" (as such term is used in Sections 13(d) and 14(d) of the Securities Exchange Act of 1934, as amended), other than a trustee or other fiduciary holding securities under an employee benefit plan of the Company, a subsidiary of the Company, or a corporation owned directly or indirectly by the shareholders of the Company in substantially the same proportions as their ownership of stock of the Company, is or becomes the "Beneficial Owner" (as defined in Rule 13d-3 under said Act), directly or indirectly, of securities of the Company representing 40% or more of the total voting power represented by the Company's then outstanding Voting Securities; (ii) during a two-year period, individuals who at the beginning of such period constitute the Board and any new director whose election or election was approved by a vote of at least two-thirds (2/3) of the directors then still in office who either were directors at the beginning of the period or whose election or nomination for election was previously so approved, cease for any reason to constitute a majority thereof; (iii) the stockholders of the Company approve a merger or consolidation of the Company with any other corporation, other than a merger or consolidation that would result in the Voting Securities of the Company outstanding immediately prior thereto continuing to represent (either by remaining outstanding or by being converted into Voting Securities of the surviving entity) at least 80% of the total voting power represented by the Voting Securities of the Company or such surviving entity outstanding immediately after such merger or consolidation, or (iv) the stockholders of the Company approve a plan of complete liquidation of the Company or an agreement for the sale or disposition by the Company (in one transaction or a series of transactions) of all or substantially all of the Company's assets. (d) "Independent Counsel" shall be the person or body appointed in connection with Section 4 of this Agreement. (e) "Other enterprises" shall include employee benefit plans. (f) "Potential Change in Control" shall be deemed to have occurred if (i) the Company enters into an agreement or arrangement, the consummation of which would result in the occurrence of a Change in Control; (ii) any person (including the Company) publicly announces an intention to take or to consider taking actions that, if consummated, would constitute a Change in Control; (iii) any "person" (as such term is used in Sections 13(d) and 14(d) of the Securities Exchange Act of 1934, as amended), other than a trustee or other fiduciary holding securities under an employee benefit plan of the Company, a subsidiary of the Company, a corporation owned directly or indirectly by the proportions as their ownership of stock of the Company, or a person who is a party to an indemnification agreement (in a form similar to this Agreement) with the Company, is or becomes the "Beneficial Owner" (as defined in Rule 13d-3 under said Act), directly or indirectly, of securities of the Company representing 15% or more of the total voting power represented by the Company's then outstanding Voting Securities; or (iv) the Board adopts a resolution to the effect that, for purposes of this Agreement, a Potential Change in Control has occurred. 2 3 (g) "Serving at the request of the Company" shall include, without limitation, any service as a director, officer, employee or agent of the Company which imposes duties on, or involves services by, Indemnitee with respect to an employee benefit plan. (h) "Voting Securities" shall mean any securities of the Company that are entitled to vote generally in the election of directors. 2. INITIAL INDEMNITY. (a) Indemnity in Third Party Proceedings. The Company shall indemnify the Indemnitee when he was or is a party or is threatened to be made a party to any threatened, pending or completed action, suit or proceeding, whether civil, administrative, investigative, or criminal (other than an action by or in the right of the Company), by reason of the fact that he is or was or had agreed to become a director, officer, employee or agent of the Company, or is or was serving or had agreed to serve at the request of the Company as a director, officer, employee or agent of another corporation, partnership, joint venture, trust or other enterprise, or by reason of any action alleged to have been taken or omitted in such capacity, against any and all costs, charges and expenses (including without limitation attorneys' and others' fees and expenses), judgments, fines and amounts paid in settlement actually and reasonably incurred by the Indemnitee in connection therewith and any appeal therefrom if the Indemnitee acted in good faith and in a manner he reasonably believed to be in or not opposed to the best interests of the Company, and with respect to any criminal action or proceeding, had no reasonable cause to believe his conduct was unlawful. The termination of any action, suit or proceeding by judgment, order, settlement, conviction or upon a plea of nolo contendere or its equivalent shall not, of itself, create a presumption that the Indemnitee did not satisfy the foregoing standard of conduct to the extent applicable thereto. (b) Indemnity in Proceedings By or In the Name of the Corporation. The Company shall indemnify the Indemnitee when he was or is a party or is threatened to be made a party to any threatened, pending or completed action, suit or proceeding by or in the right of the Company to procure a judgment in its favor by reason of the fact that he is or was or had agreed to become a director, officer, employee or agent of the Company, or is or was serving or had agreed to serve at the request of the Company as a director, officer, employee or agent of another corporation, partnership, joint venture, trust or other enterprise against costs, charges and expenses (including attorneys' and others' fees and expenses) actually and reasonably incurred by him in connection with the defense or settlement thereof or any appeal therefrom if he acted in good faith and in a manner he reasonably believed to be in or not opposed to the best interests of the Company and except that no indemnification shall be made in respect of any claim, issue or matter as to which the Indemnitee shall have been adjudged to be liable to the Company unless and only to the extent that the Court of Chancery or the court in which such action, suit or proceeding was brought shall determine upon application that, despite the adjudication of liability but in view of all the circumstances of the case, the Indemnitee is fairly and reasonably entitled to indemnity for such expenses which the Court Chancery or such other court shall deem proper. (c) Indemnification of Expenses of Successful Party. To the extent that the Indemnitee has been successful on the merits or otherwise, including, without limitation the dismissal of an action without prejudice, in defense of any action, suit or proceeding referred to in Sections 2(a) or 2(b) hereof or in defense of any claim, issue or matter therein, he shall be indemnified against costs, charges and expenses (including attorney's and others' fees and expenses) actually and reasonably incurred by him in connection therewith. 3 4 (d) Determination of Right on Indemnitee to Indemnification. Any indemnification under Sections 2(a) or 2(b) (unless ordered by a court) shall be made by the Company only as authorized in the specific case upon a determination in accordance with Section 4 hereof or any applicable provision of the Certificate, Bylaws, other agreement, resolution or otherwise. Such determination shall be made (i) by the Board by a majority vote of a quorum consisting of directors who were not parties to such action, suit or proceeding or (ii) if such a quorum of disinterested directors is not available or so directs, by independent legal counsel (designated in the manner provided below in this subsection (d)) in a written opinion or (iii) by the stockholders of the Company (the "Stockholders"). Independent legal counsel shall be designated by vote of a majority of the disinterested; provided, however, that if the Board is unable or fails to so designate, such designation shall be made by the Indemnitee subject to the approval of the Company (which approval shall not be unreasonably withheld). Independent legal counsel shall not be any person or firm who, under the applicable standards professional conduct then prevailing, would have a conflict of interest in representing either the Company or the Indemnitee in an action to determine the Indemnitee's rights under this Agreement. The Company agrees to pay the reasonable fees and expenses of such independent legal counsel and to indemnify fully such counsel against costs, charges and expenses (including attorneys' and others' fees and expenses) actually and reasonably incurred by such counsel in connection with this Agreement or the opinion of such counsel pursuant hereto. (e) Advancement of Expenses. All expenses (including attorneys' and others' fees and expenses) incurred by the Indemnitee in his capacity as a director or officer of the Company in defending a civil or criminal action, suit or proceeding shall be paid by the Company in advance of the final disposition of such action, suit or proceeding in the manner prescribed by Section 4(b) hereof. 3. Additional Indemnification. (a) Right to additional Indemnification. Pursuant to Section 145 (f) of the General Corporation Law of the State of Delaware (the "GCL"), without limiting any right which the Indemnitee may have pursuant to Section 2 hereof, the Certificate, the Bylaws, the GCL, any policy of insurance or otherwise, but subject to the limitations on the maximum permissible indemnity which may exist under applicable law at the time of any request for indemnity hereunder determined as contemplated by this Section 3(a), the Company shall indemnify the Indemnitee against any amount which he is or becomes legally obligated to pay relating to or arising out of any claim made against him because of any act, failure to act or neglect or breach of duty, including any actual or alleged error, misstatement or misleading statement, which he commits, suffers, permits or acquiesces in while acting in his capacity as a director, an officer, an employee or agent of the Company, or, at the request of the Company, as a director, officer, employee or agent of another corporation, partnership, joint venture, trust or other enterprise, whether prior to or after the date of this Agreement and whether or not the basis of the claim is alleged action or inaction in an official capacity as a director, officer, employee or agent or in any other capacity while serving as a director, officer, employee or agent or in any other capacity while serving as a director, officer, employee or agent of the Company. The payments which the Company is obligated to make pursuant to this Section 3 shall include without limitation (i) damages, judgments, settlements (in accordance with Section 6(d) of this Agreement), fines and similar penalties, and excise taxes and penalties assessed on a person with respect to an employee benefit plan, (ii) charges costs expenses (including attorneys' and others' fees and related disbursements), expenses of investigation, expenses of defense of legal actions, suits, proceedings or claims and appeals therefrom, expenses relating to serving as a witness and expenses of appeal, attachment or similar bonds, and (iii) any interest, assessments, or other charges imposed thereon and any federal, state, local or foreign taxes imposed as a result of the actual or deemed receipt of such payments under this Agreement. Notwithstanding the foregoing, the Company shall not be obligated under this Section 3(a) to make any payment in connection with any claim against he Indemnitee: 4 5 (i) to the extent of any fine or similar governmental imposition which the Company is prohibited by applicable law from paying which results in a final, nonappealable order; or (ii) to the extent based upon or attributable to the Indemnitee gaining in fact a personal profit to which he was not legally entitled, including without limitation profits made from the purchase and sale by the Indemnitee of equity securities of the Company which are recoverable by the Company which are recoverable by the Company pursuant to Section 16(b) of the Securities Exchange Act of 11934, as amended, and profits arising from transactions in publicly traded securities of the Company which were effected by the Indemnitee in violation of Section 10(b) of the Securities Exchange Act of 1934, as amended, including Rule 10b-5 promulgated thereunder. The determination of whether the Indemnitee shall be entitled to indemnification under this section 3(a) shall be made in accordance with section 4(d) hereof. (b) Advancement of Expenses Relating to Additional Indemnification. Expenses (including without limitation attorneys' and others' fees and expenses) incurred by Indemnitee in defending any actual or threatened civil or criminal action, suit, proceeding or claim shall be paid by the Company in advance of the final disposition thereof as authorized in accordance with Section 4(b) hereof. 4. Certain Procedures Relating to Indemnification and Advancement of Expenses. (a) General. Except as otherwise permitted or required by the GCL, for purposes of pursuing his rights to indemnification under Sections 2(a), 2(b), or 3(a) hereof, as the case may be, the Indemnitee may, but shall not be required to, (i) submit to the Board a sworn statement of request for indemnification substantially in the form of Exhibit 1 attached hereto and made a part hereof (the "Indemnification Statement") averring that he is entitled to indemnification hereunder; and (ii) present to the Company reasonable evidence of all expenses for which payment is requested. Submission of an Indemnification Statement to the Board shall create a presumption that the Indemnitee is entitled to indemnification under Sections 2(a), 2(b) or 3(a) hereof, as the case may be, and the Board shall be deemed to have determined that the Indemnitee is entitled to such indemnification unless with in 30 calendar days after submission of the Indemnification Statement the Board shall determine by vote of a majority of the directors at a meeting at which a quorum is present, based upon clear and convincing evidence (sufficient to rebut the foregoing presumption), and the Indemnitee shall have received notice within such period in writing of such determination that the Indemnification is not so entitled to indemnification, which notice shall disclose with particularity the evidence in support of the Board's determination. The foregoing notice shall be sworn to by all persons who participated in the determination and voted to deny indemnification. The provisions of this section 4(a) are intended to be procedural only and shall not affect the right of the Indemnitee to indemnification under this Agreement and any determination by the Board that the Indemnitee is not entitled to indemnification and any failure to make the payments requested in the Indemnification Statement shall be subject to judicial review as provided in Section 5 hereof. 5 6 (b) Undertaking or Expense Request Regarding Advancement of Expenses. For purposes of determining whether to authorize advancement of expenses pursuant to Section 2(e) hereof, the Indemnitee shall submit to the board a sworn statement of request for advancement of expenses substantially in the form of Exhibit 2 attached hereto and made a part hereof (the "Undertaking"), averring that (i) he has reasonably incurred or will reasonably incur actual expenses in defending an actual civil or criminal action, suit, proceeding or claim and (ii) he undertakes to repay such amount if it shall ultimately be determined that he is not entitled to be indemnified by the Company under this Agreement or otherwise. For purposes of requesting advancement of expenses pursuant to Section 3(b) hereof, the Indemnitee (i) may, but shall not be required to, submit an Undertaking or (ii) shall submit such other form of request as he determines to be appropriate (an "Expense Request"). Upon receipt of an Undertaking or Expense Request, as the case may be, the Board shall within 20 calendar days authorize immediate payment of the expenses stated in the Undertaking or Expense Request, whereupon such payments shall immediately be made by the Company. No security shall be required in connection with any Undertaking or Expense Request and any Undertaking or Expense Request shall be accepted without reference to the Indemnitee's ability to make repayment. (c) Independent Counsel. Notwithstanding anything to the contrary contained in Sections 2(d) or 4(a) of this Agreement, after a Change of Control and if requested by the Indemnitee at the time of making a claim for indemnification, (i) any determination under Section 2(a) or 2(b) (unless ordered by a court) shall be made by Independent Counsel (as defined below), and (ii) after the submission of an Indemnification Statement, the determination pursuant to Section 4(a) whether an Indemnitee shall be entitled to indemnification under Sections 2(a), 2(b) or 3(a) hereof, as the case may be, shall be made by Independent Counsel (as defined below) instead of by the Board. For purposes of this Section 4(c) "Independent Counsel" shall be an attorney selected by Indemnitee and approved by the Company (which approval shall not be unreasonably withheld), (i) who has not otherwise performed services for the Company or the Indemnitee (other than in connection with indemnification matters) within the three years prior to the selection of the Independent Counsel, and (ii) who shall not, under the applicable standards of professional conduct then prevailing, have a conflict of interest in representing either the Company or Indemnitee in an action to determine Indemnitee's rights under this Agreement. Any determination by Independent Counsel as to whether and to what extent the Indemnitee should be permitted to be indemnified under applicable law shall be rendered by its written opinion to the Company and Indemnitee. The Company agrees to pay the reasonable fees of the Independent Counsel and to indemnify fully such counsel against any and all expenses (including attorneys' and others' fees and expenses), claims, liabilities, loss, and damages arising out of or relating to this Agreement, the engagement of Independent Counsel pursuant hereto or the opinion of such counsel pursuant hereto. 5. Indemnification Process and Appeal. (a) Suit to Enforce Rights. If a claim for indemnification made to the Company pursuant to Section 4 hereof is not paid in full by the Company within 30 calendar days after a written claim has been received by the Company, the Indemnitee may at any time thereafter bring suit against the Company to recover the unpaid amount of the claim in any court having subject matter jurisdiction thereof. The Company hereby consents to service of process and to appear in any such proceeding. The remedy provided for in this Section 5 shall be in addition to any other remedies available to Indemnitee in law or equity. 6 7 (b) Defense to Indemnification, Burden of Proof and Presumptions. In any action brought under Section 5(a) hereof, it shall be a defense to a claim for indemnification pursuant to Sections 2(a) or 2(b) hereof (other than an action brought t enforce a claim for expenses incurred in defending any proceeding in advance of its final disposition where the Undertaking, if any is required, has not met the standards of conduct which make it permissible under the GCL for the Company to indemnify the Indemnitee for the amount claimed, but the burden of proving such defense shall be on the Company. It shall be a defense to any action brought by Indemnitee against the Company to enforce this Agreement that it is not permissible under applicable law for the Company to indemnify Indemnitee for the amount claimed, but the burden of proving such defense shall be on the Company. Neither the failure of the Company (including its Board, independent legal counsel or its stockholders) or Independent counsel to have made a determination prior to the commencement of such action by Indemnitee that indemnification of the claimant is proper under the circumstances because he has met the standard of conduct set forth in applicable law, nor an actual determination by the Company (including its Board, independent legal counsel or its stockholders) or Independent Counsel that Indemnitee had not met such applicable standard of conduct, shall be a defense to the action or create a presumption that Indemnitee has not met the applicable standard of conduct. (c) Indemnification for Expenses Incurred in Enforcing Rights. It is the intent of the Company that the Indemnitee not be required to incur the expenses associated with the enforcement of his rights under this Agreement by litigation or other legal action because the cost and expense thereof would substantially detract from the benefits intended to be extended to the Indemnitee hereunder. Accordingly, if it should appear to the Indemnitee that the Company has failed to comply with any of its obligations under the Agreement or in the event that the Company or any other person takes any action to declare the Agreement void or proceeding designed (or having the effect of being designed) to deny, or to recover from, the Indemnitee the benefits intended to be provided to the Indemnitee hereunder, the Company irrevocably authorizes the Indemnitee from time to time to retain counsel of his choice, at the expense of the Company as hereafter provided, to represent the Indemnitee in connection with the initiation or defense of any litigation or other legal action, whether by or against the Company or any director, officer, stockholder or other person affiliated with the Company, in any jurisdiction. Regardless of the outcome thereof, the Company shall pay and be solely responsible for any and all costs, charges and expenses (including without limitation attorneys' and others' fees and (expenses) reasonably incurred by the Indemnitee (i) as a result of the Company's failure to perform this Agreement or any provision thereof or (ii) as a result of the Company or any other person contesting the validity or enforceability of this Agreement or any provision thereof as aforesaid; provided that, if and to the extent that a court of competent jurisdiction determines (in a final judicial determination as to which all rights of appeal therefrom have been exhausted or waived or have lapsed) that each of the material assertions made by Indemnitee in such litigation or other legal action was not made in good faith or was frivolous, the Company shall not be obligated to pay any such costs, charges and expenses incurred by Indemnitee in connection with such suit and shall be entitled to be reimbursed by Indemnitee (who hereby agrees to reimburse the Company) for all such amounts theretofore paid under this Section 5(c). Notwithstanding the procedure for selection of counsel in Section 6(c) herein, in connection with the assertion of any claim under this Section 5(c), Indemnitee from time to time may retain counsel of his choice to represent him. 6. Notification and Defense of Proceeding. (a) Notice/Cooperation by Indemnitee. Indemnitee shall give the Company notice in writing as soon as practicable of any claim made against Indemnitee for which indemnification will or could be sought under this Agreement (for purposes of this Section 6, a "Claim"). Indemnitee shall also provide the Company such information and cooperation as the Company from time to time may reasonably request and as shall reasonably be within Indemnitee's power to provide. 7 8 (b) Notice to Insurers. If at the time of the receipt of a notice of a Claim pursuant to Section 6(a) hereof the Company has directors' and officers' liability insurance (or a similar policy covering key employees, if applicable) in effect, the Company shall give prompt notice of such Claim to the insurers in accordance with the procedures set forth in the respective policies. The Company thereafter shall take all necessary or desirable action to cause such insurers to pay, on behalf of Indemnitee, all amounts payable as a result of such Claim in accordance with the terms of such policies. (c) Selection of Counsel. With respect to any litigation or other legal action relating to a Claim as to which Indemnitee notifies the Company (for purposes of this Section 6, a "Proceeding"), the Company will be entitled to participate in the Proceeding at its own expense and except as otherwise provided below, to the extent the Company so wishes, it may assume the defense thereof with counsel selected by the Company and approved by Indemnitee, which approval shall not be unreasonably withheld. After notice from the Company to Indemnitee of its election to assume the defense of any Proceeding, the Company will not be liable to Indemnitee under this Agreement or otherwise for any expenses subsequently incurred by Indemnitee in connection with the defense of such Proceeding other than reasonable costs of investigation or as otherwise provided below. Indemnitee shall have the right to employ his own counsel in such Proceeding, but all expenses related thereto incurred after notice from the Company of its assumption of the defense shall be at Indemnitee's expense unless: (i) the employment of counsel by Indemnitee has been authorized by the Company; (ii) Indemnitee has reasonably determined and either the Company shall have agreed, or disinterested counsel (as defined in this Section 6(c)) shall have determined, that there may be a conflict of interest between Indemnitee and the Company in the defense of the Proceeding; (iii) after a Change in Control, the employment of counsel by Indemnitee has been approved by the Independent Counsel; or (iv) the Company shall not in fact have employed counsel to assume the defense of such Proceeding, in each of which case all expenses of the Proceeding shall be borne by the Company, and Indemnitee's counsel shall have been approved by the Company (which approval may not be unreasonably withheld) and any carrier of an applicable insurance policy if required under the terms of that policy or under applicable law. As used in this Section 6(c), "disinterested counsel" shall mean counsel selected and compensated by the Company, and approved by Indemnitee (which approval may not be unreasonably withheld), to determine whether a conflict of interest may exist, which counsel shall not represent the Company, Indemnitee or any other party to the Proceeding for which indemnification is sought. Disinterested counsel shall be selected promptly following the notice from Indemnitee to the Company of Indemnitee's belief that a conflict of interest may exist. The company shall not be entitled to assume the defense of any Proceeding as to which the determination provided for in (ii) above shall have been made. Nothing herein shall limit the right of Indemnitee to employ counsel at Indemnitee's sole expense. (d) Settlements. Notwithstanding anything to the contrary contained in this Agreement, the Company shall not be liable to indemnify Indemnitee under this Agreement or otherwise for any amounts paid in settlement of any Proceeding effected without the Company's written consent; provided, however, that if a Change in Control has occurred, the Company shall be liable for indemnification of Indemnitee for amounts paid in settlement if the Independent Counsel has approved the settlement. The Company shall not settle any Proceeding in any manner that would impose any penalty or limitation on Indemnitee without Indemnitee's written consent. Neither the Company nor the Indemnitee will unreasonably withhold its consent to any proposed settlement. The Company shall not be liable to indemnify Indemnitee under this Agreement with regard to any judicial award if the Company was not given a reasonable and timely opportunity, at its expense, to participate in the defense of such action; the Company's liability hereunder shall not be excused if participation in the Proceeding by the Company was barred by this Agreement. 8 9 7. Establishment of a Trust. Immediately upon the occurrence of a Change in Control or a Potential Change in Control, the Company shall, upon written request by Indemnitee, create a trust (a "Trust") for the benefit of Indemnitee and from time to time upon written request of Indemnitee shall fund the Trust in an amount sufficient to satisfy any and all amounts reasonably anticipated at the time of each such request to be incurred in connection with any claim made by Indemnitee. The amount or amounts to be deposited in the Trust pursuant to the foregoing funding obligation shall be determined (i) prior to the occurrence of a Change in Control or a Potential Change in Control, (a) the Board by a majority vote of a quorum consisting of directors who were not parties to the action, suit or proceeding serving as the basis of a claim by Indemnitee, or (b) if such a quorum of disinterested directors is not available or so directs, by independent legal counsel (designated in the manner provided in Section 2(d) in a written opinion or (c) by the Stockholders, or (ii) after the occurrence of a Change in Control or a Potential Change in Control, by Independent Counsel as defined in Section 4(c) (for purposes of this Section 7, the "Reviewing Party"). The terms of the Trust shall provide that upon a Change in Control (i) the Trust shall not be revoked or the principal thereof invaded without the written consent of Indemnitee, (ii) the trustee of the Trust (the "Trustee") shall advance within 20 business days of the request by Indemnitee, any and all expenses to Indemnitee (and Indemnitee hereby agrees to reimburse the Trust under the same circumstances for which Indemnitee would be required to reimburse the Company under Section 4(b) of this Agreement), (iii) the Trust shall continue to be funded by the Company in accordance with the funding obligation set forth above, (iv) the Trustee shall promptly pay to Indemnitee all amounts for which Indemnitee shall be entitled to indemnification pursuant to this Agreement or otherwise, and (v) all unexpended funds in the Trust shall revert to the Company upon a final determination by the Reviewing Party or a court of competent jurisdiction, as the case may be, that Indemnitee has been fully indemnified under the terms of this Agreement. The Trustee shall be chosen by Indemnitee. Nothing in this Section 7 shall relieve the Company of any of its obligations under this Agreement. All income earned on the assets held in the Trust shall be reported as income by the Company for federal, state, local and foreign tax purposes. The Company shall pay all costs of establishing and maintaining the Trust and shall indemnify the Trustee against any and all expenses (including attorneys' fees), claims, liabilities, loss and damages arising out of or relating to this Agreement or the establishment and maintenance of the Trust.. 8. Exceptions. Any other provision herein to the contrary notwithstanding, the Company shall not be obligated pursuant to the terms of this Agreement: (a) Claims Initiated by Indemnitee. To indemnify Indemnitee for any amounts or to advance expenses to Indemnitee with respect to any litigation or other legal action initiated or brought voluntarily (and not by way defense or counterclaim) by Indemnitee against the Company or any agent of the Company unless (i) the Company has joined in or the Board has consented to the initiation of such litigation or other legal action, (ii) the litigation or other legal action is brought to establish or enforce a right to indemnification under Section 5 of this Agreement, or (iii) the litigation or other legal action is instituted after a Change of Control and Independent Counsel has approved its initiation; or (b) No Duplication of Payments. To make any payment in connection with any claim made against Indemnitee to the extent Indemnitee has otherwise actually received payment (under any insurance policy, by law or otherwise) of the amounts otherwise indemnifiable hereunder. 9 10 9. Scope; Nonexclusivity. (a) Scope. In accordance with Section 145(f) of the GCL, the parties hereto intend that this Agreement shall provide for indemnification in excess of that expressly permitted by statute, including, without limitation, any indemnification provided by the Certificate, Bylaws, vote of its stockholders or disinterested directors or applicable law. To the extent that a change in applicable law (whether by statue, rule or judicial decision) permits greater indemnification by agreement than would be afforded currently under the Certificate, Bylaws, applicable law or this Agreement, it is the intent of the parties that Indemnitee enjoy by this Agreement the greater benefits so afforded by such change. (b) Nonexclusivity. Consistent with Section 145(f) of the GCL, the indemnification provided by this Agreement shall not be deemed exclusive of any rights to which Indemnitee may be entitled under the Certificate, Bylaws, any agreement, any vote of stockholders or disinterested directors, or otherwise, both as to actions in Indemnitee's official capacity and as to actions in another capacity while holding such office, and shall continue after Indemnitee has ceased to be a director, officer, employee or agent. 10. Mutual Acknowledgment. Both the Company and Indemnitee acknowledge that in certain instances, federal or state law or applicable public policy may prohibit the Company from indemnifying its directors, officers, employees or other agents under this Agreement or otherwise. Indemnitee understands and acknowledges that the Company has undertaken or may be required in the future to undertake with the U.S. Securities and Exchange Commission or applicable state securities agencies to submit the question of indemnification to a court in certain circumstances for a determination of the Company's right under public policy to indemnify Indemnitee. 11. Directors' and Officers' Liability Insurance. The Company shall, from time to time, make the good faith determination whether or not it is practical for the Company to obtain and maintain a policy or policies of insurance with reputable insurance companies providing the officers and directors of the Company with coverage for losses from wrongful acts, or to ensure the Company's performance of its indemnification obligations under this Agreement. Among other considerations, the Company will weigh the costs of obtaining such insurance coverage against the protection afforded by such coverage. To the extent the Company maintains an insurance policy or policies providing directors' and officers' liability insurance (or such other similar insurance policy covering key employees, if applicable), Indemnitee shall be covered by such policy or policies, in accordance with its or their terms, to the maximum extent of the coverage available for any Company director or officer. Notwithstanding the foregoing, the Company shall have no obligation to obtain or maintain such insurance if the Company determines in good faith that such insurance is not reasonably available, if the premium costs for such insurance are disproportionate to the amount of coverage provided, if the coverage provided by such insurance is limited by exclusions so as to provide an insufficient benefit, or if Indemnitee is covered by similar insurance maintained by a subsidiary or parent Company. 10 11 12. Effectiveness of Agreement. This Agreement shall be effective as of the date set forth on the first page and may apply to acts or omissions of Indemnitee which occurred prior to such date if Indemnitee was a director, officer, employee or agent of the Company, or was serving at the request of the Company as a director, officer, employee or agent of another corporation, partnership, joint venture, trust or other enterprise, at the time such act or omission occurred. This Agreement supersedes and replaces the Indemnification Agreement, dated as of June 10, 1988 (the "California Indemnification Agreement"), between The Clothestime, Inc., a California corporation and a predecessor to the Company ("Clothestime-California"), and the Indemnitee, and the Company hereby assumes all of the obligations, responsibilities and liabilities of ClothestimeCalifornia under the California Indemnification Agreement. 13. Period of Limitation. No legal action shall be brought and no cause of action shall be asserted by or on behalf of the Company or any affiliate of the Company against Indemnitee, Indemnitee's spouse, heirs, executors, or personal or legal representatives after the expiration of two years from the date of accrual of such cause of action, or such longer period as may be required by state law under the circumstances (i.e., a minimum limitation period that expressly may not be altered by agreement among the parties). Any claim or cause of action of the Company or any of its affiliates shall be extinguished and deemed released unless asserted by the timely filing of a legal action within such period; provided, however, if any shorter period of limitation is otherwise applicable to any such cause of action, the shorter period shall govern. 14. Ratification of Acts. None of the provisions contained in this Agreement is intended to constitute, or shall be construed in any manner as constituting, a ratification by the Company (or by any of its directors, officers or other agents) of any action or inaction on the part of Indemnitee. 15. Continued Employment. No provision contained herein shall be construed as conferring upon Indemnitee any right with respect to continuance of performance of services for the Company, nor shall any such provisions interfere in any way with the right of the Company to terminate Indemnitee's services as an officer, employee or other agent at any time with or without cause. 11 12 16. Successors and Assigns. This agreement shall be binding upon, inure to the benefit of and be enforceable by the parties hereto and their respective successors (including any direct or indirect successor by purchase, merger, consolidation or otherwise to all or substantially all of the business and/or assets of the Company), assigns, spouses, heirs and personal and personal and legal representatives. The Company shall require and cause any successor (whether direct or indirect by purchase, merger, consolidation or otherwise) to all, substantially all, or a substantial part, of the business and/or assets of the Company, by written agreement in form and substance satisfactory to Indemnitee, expressly to assume and agree to perform this Agreement in the same manner and to the same extent that the Company would be required to perform if no such succession had taken place. Nothing in this Section 16 shall be construed to limit the protections afforded Indemnitee under this Agreement which would occur upon a Change in Control or a Potential Change in Control. The indemnification provided under this Agreement shall continue as to Indemnitee for any action taken or not taken while serving in an indemnified capacity even though Indemnitee may have ceased to serve in such capacity at the time of any litigation or other legal action relating to events for which a claim for indemnification is made by Indemnitee hereunder. 17. Notice. All notices, requests, demands and other communications under this Agreement shall be in writing and shall be deemed duly given (i) if delivered by hand and receipted for by the party addressed, on the date of such receipt, or (ii) if mailed by domestic certified or registered mail with postage prepaid, on the third business day after the date postmarked. Addresses for notice to either party are as shown on the signature page of this Agreement, or as subsequently modified by written notice. 18. Choice of Law. This Agreement shall be governed by, and its provisions construed in accordance with, the laws of the State of Delaware, including without limitation, all matters of formation, construction, validity, performance and enforcement and without giving effect to the principals of conflicts of laws. 19. Severability. Nothing in this Agreement is intended to require or shall be construed as requiring the Company to do or fail to do any act in violation of applicable law. The Company's inability, pursuant to court order, to perform its obligations under this Agreement shall not constitute a breach of this Agreement. The provisions of this Agreement shall be severable as provided in this Section 19. If this Agreement or any portion hereof shall be invalidated or held unlawful or unenforceable on any ground by any court of competent jurisdiction, then the Company shall nevertheless indemnify Indemnitee to the full extent permitted by any applicable portion of this Agreement that shall not have been invalidated or held unlawful or unenforceable, the provision(s) so held to be invalid, unenforceable or otherwise illegal shall be reformed to the extent (and only to the extent) necessary to make it enforceable, valid and legal and the balance of this Agreement shall be enforceable in accordance with its terms. Furthermore, to the fullest extent possible, the provisions of this Agreement (including, without limitation, each portion of this Agreement containing any provision held to be invalid, void, or otherwise unenforceable, that is not itself invalid, void or unenforceable) shall be construed so as to give effect to the intent manifested by the provision held invalid, void or unenforceable. 12 13 20. Amendment and Waiver. No supplement, modification or amendment of this Agreement shall be binding unless executed in writing by both of the parties hereto. No waiver of any of the provisions of this Agreement shall be deemed or shall constitute a waiver of any other provision hereof (whether or not similar), nor shall such waiver constitute a continuing waiver. Except as specifically provided herein, no failure to exercise or any delay in exercising any right or remedy hereunder shall constitute a waiver thereof. 21. Subrogation. In the event of payment under this Agreement, the Company shall be subrogated to the extent of such payment to all of the rights of recovery of Indemnitee, that may be necessary to secure such rights, including the execution of such documents necessary to enable the Company effectively to bring suit to enforce such rights. 22. Future Agreements. The Company shall not adopt any amendment to its Certificate or Bylaws the effect of which would be to deny, diminish or encumber Indemnitee's rights to indemnity pursuant to the Certificate, the Bylaws, the GCL or any other applicable law as applied to any act or failure to act occurring in whole or in part prior to the date (the "Effective Date") upon which the amendment was approved by the Board or the stockholders, as the case may be. In the event that the Company shall adopt any amendment to its Certificate or Bylaws the effect of which is to so deny, diminish or encumber Indemnitee's rights to indemnity, such amendment shall apply only to acts or failures to act occurring entirely after the Effective Date thereof unless the Indemnitee shall have voted in favor of such adoption as a director or holder of record of the Company's Voting Securities, as the case may be. 23. Counterparts. This Agreement may be executed in counterparts, each of which shall be deemed an original but all of which counterparts taken together shall constitute one and the same document. 13 14 24. Headings. Section headings herein are for reference purposes only and shall not affect the meaning or interpretation of any provision of this Agreement. IN WITNESS WHEREOF, the parties hereto have executed this Agreement as of the date first above written. THE CLOTHESTIME, INC. By: /s/ David A. Sejpal - ------------------------------------ David A. Sejpal Vice President of Finance Chief Financial Officer AGREED TO AND ACCEPTED: INDEMNITEE; By: /s/ Charles Castaneda - ------------------------------------ Charles Castaneda Vice President, Merchandise Planning And Control 14 15 EXHIBIT 1 INDEMNIFICATION STATEMENT STATE OF _____________ ) ) SS COUNTY OF _____________ ) I, ____________________, BEING FIRST DULY SWORN, DO DEPOSE AND SAY AS FOLLOWS: 1. THIS INDEMNIFICATION STATEMENT IS SUBMITTED PURSUANT TO THE INDEMNIFICATION AGREEMENT, DATED AS OF __________________________, 199__, BETWEEN THE CLOTHESTIME, INC. (THE "COMPANY"), A DELAWARE CORPORATION, AND THE UNDERSIGNED. 2. I AM REQUESTING INDEMNIFICATION AGAINST CHARGES, COSTS, EXPENSES (INCLUDING ATTORNEYS' AND OTHERS' FEES AND EXPENSES), JUDGMENTS, FINES AND AMOUNTS PAID IN SETTLEMENT, ALL OF WHICH HAVE BEEN OR WILL BE INCURRED BY ME IN CONNECTION WITH AN ACTUAL OR THREATENED ACTION, SUIT, PROCEEDING OR CLAIM TO WHICH I AM A PARTY OR AM THREATENED TO BE MADE A PARTY. 3. WITH RESPECT TO ALL MATTERS RELATED TO ANY SUCH ACTION, SUIT, PROCEEDING OR CLAIM, I AM ENTITLED TO BE INDEMNIFIED AS HEREIN CONTEMPLATED PURSUANT TO THE AFORESAID INDEMNIFICATION AGREEMENT. 4. WITHOUT LIMITING ANY OTHER RIGHTS WHICH I HAVE OR MAY HAVE, I AM REQUESTING INDEMNIFICATION AGAINST LIABILITIES WHICH HAVE OR MAY ARISE OUT OF _______________________________________________________________________ _______________________________________________________________________ _______________________________________________________________________ _____________________________ SUBSCRIBED AND SWORN TO BEFORE ME, A NOTARY PUBLIC IN AND FOR SAID COUNTY AND STATE, THIS _________ DAY OF ____________________, 19 ___. _____________________________ (SEAL) MY COMMISSION EXPIRES THE ______ DAY OF ___________________, 19 ___. 15 16 EXHIBIT 2 INDEMNIFICATION STATEMENT STATE OF _____________ ) ) SS COUNTY OF _____________ ) I, __________________, BEING FIRST DULY SWORN TO DEPOSE AND SAY AS FOLLOWS: 1. THIS UNDERTAKING IS SUBMITTED PURSUANT TO THE INDEMNIFICATION AGREEMENT, DATED AS OF _________________, 19 __, BETWEEN THE CLOTHESTIME, INC. (THE "COMPANY"), A DELAWARE CORPORATION AND THE UNDERSIGNED. 2. I AM REQUESTING ADVANCEMENT OF CERTAIN COSTS, CHARGES AND EXPENSES WHICH I HAVE INCURRED OR WILL INCUR IN DEFENDING AN ACTUAL OR PENDING CIVIL OR CRIMINAL ACTION, SUIT, PROCEEDING OR CLAIM. 3. I HEREBY UNDERTAKE TO REPAY THIS ADVANCEMENT OF EXPENSES IF IT SHALL ULTIMATELY BE DETERMINED THAT I AM NOT ENTITLED TO BE INDEMNIFIED BY THE COMPANY UNDER THE AFORESAID AGREEMENT OR OTHERWISE. 4. THE COSTS, CHARGES AND EXPENSES FOR WHICH ADVANCEMENT IS REQUESTED ARE, IN GENERAL, ALL EXPENSES RELATED TO ________________________________________________________________________ ________________________________________________________________________ ________________________________________________________________________ ____________________________ SUBSCRIBED AND SWORN TO BEFORE ME, A NOTARY PUBLIC IN AND FOR SAID COUNTY AND STATE, THIS _________ DAY OF ____________________, 19 ___. ____________________________ (SEAL) MY COMMISSION EXPIRES THE ______ DAY OF ___________________, 19 ___. 16 EX-10.55 5 FINANCING AGREEMENT CIT GROUP/BUSINESS CREDIT, INC 1 EXHIBIT 10.55 EXECUTION COPY ==================================== FINANCING AGREEMENT THE CIT GROUP/BUSINESS CREDIT, INC. as Lender And CLOTHESTIME STORES, INC. as Debtor and Debtor in Possession as Borrower And THE CLOTHESTIME, INC. MRJ INDUSTRIES, INC. CLOTHESTIME INVESTMENT, INC. CLOTHESTIME INTERNATIONAL, INC. AND CLOTHESTIME ACQUISITION CORPORATION as Debtors and Debtors in Possession as Guarantors Dated as of December 28, 1995 ==================================== 2 EXECUTION COPY FINANCING AGREEMENT This Financing Agreement is dated as of December 28, 1995, and is entered into by and among THE CIT GROUP/BUSINESS CREDIT, INC., a New York corporation (hereinafter referred to as "CITBC"), with offices located at 300 South Grand Avenue, Los Angeles, CA 90071, CLOTHESTIME STORES, INC., a Delaware corporation (hereinafter referred to as the "Borrower") with its principal place of business located at 5325 East Hunter Avenue, Anaheim, California 92807, as debtor and debtor in possession in a bankruptcy case commenced under Chapter 11 of the United States Bankruptcy Code, and THE CLOTHESTIME, INC., MRJ INDUSTRIES, INC., CLOTHESTIME INVESTMENT, INC., CLOTHESTIME INTERNATIONAL, INC., and CLOTHESTIME ACQUISITION CORPORATION, all Delaware corporations (hereinafter referred to as the "Guarantors") with their principal place of business at 5325 East Hunter Avenue, Anaheim, California 92807, as debtors and debtors in possession in bankruptcy cases commenced under Chapter 11 of the United States Bankruptcy Code. RECITALS A. On December 8, 1995, the Borrower and the Guarantors filed voluntary petitions for relief under Chapter 11 of the United States Bankruptcy Code with the United States Bankruptcy Court for the Central District of California. An order directing joint administration of the bankruptcy cases so commenced was entered therein on December 8, 1995. The Borrower and the Guarantors are operating their businesses and managing their affairs as debtors in possession pursuant to Sections 1107 and 1108 of the Bankruptcy Code. No trustee or examiner has been appointed in any of the Chapter 11 cases. B. The Borrower and the Guarantors have applied to CITBC for a $40,000,000 financing facility to be used by the Borrower for working capital and other purposes. C. CITBC is willing to provide such a financing facility on the terms and subject to the conditions set forth herein, including, but not limited to, the agreement of the Guarantors to guarantee payment of the Obligations as set forth in the Guaranty and the agreement of the Borrower and the Guarantors that all their present and future liabilities for payment of Obligations from time to time outstanding hereunder shall constitute an allowed administrative expense in each of the Chapter 11 bankruptcy cases that shall have, pursuant to Section 364(c)(1) of the Bankruptcy 3 EXECUTION COPY Code, priority over all administrative expenses of the kind specified in Sections 503(b) and 507(b) of the Bankruptcy Code. AGREEMENT NOW, THEREFORE, for good and valuable consideration, the receipt and adequacy of which are hereby acknowledged, the parties hereto hereby agree as follows: SECTION 1. DEFINITIONS As used in this Agreement: AFFILIATE has the meaning given to such term in Section 101(2) of the Bankruptcy Code. APPROVAL ORDERS means the Interim Approval Order and the Final Approval Order. AVAILABILITY means, at any time of determination, the amount by which (A) the lowest of (i) the Line of Credit at such time, (ii) the Borrowing Base at such time, and (iii) the amount approved for borrowing hereunder by the Bankruptcy Court upon entry of the Interim Approval Order or, after entry of the Final Approval Order, in the Final Approval Order, exceeds (B) the sum of (i) the aggregate outstanding amount of all Obligations, except reimbursement obligations for amounts undrawn under outstanding Letters of Credit and for unreimbursed drawings under Letters of Credit, and (ii) the Availability Reserve. AVAILABILITY RESERVE means, at any time of determination, an amount equal to the sum of (i) 40% of the maximum amount that is or may become available for drawing, but has not been drawn, under Letters of Credit that are commercial letters of credit (x) issued to a supplier to cover the purchase price of goods that will be Eligible Inventory when delivered to the Borrower and (y) available for drawing against delivery of documents evidencing the shipment or delivery of such goods to the Borrower, (ii) 100% of the maximum amount that is or may become available for drawing, but has not been drawn, under all other outstanding Letters of Credit, (iii) 100% of all amounts at any time drawn under Letters of Credit for which the Borrower has not yet reimbursed the Issuing Bank, (iv) the amount of all unpaid sales taxes collected by the Borrower and owing to any state or other governmental authority, except to the extent that the Borrower can demonstrate to CITBC's satisfaction that the applicable taxing authority could not recover such taxes from or in 2 4 EXECUTION COPY priority over CITBC, whether by assertion of a lien or through a trust fund or other theory, except that if and so long as no Default or Event of Default is Continuing, such amount shall not exceed $500,000, (v) the amount of any Special Payments Reserve established by CITBC for such time, (vi) the amount of any Proceeds Settlement Payment Reserve then in effect, and (vii) if and so long as any Default or Event of Default is Continuing, $500,000, reflecting the Case Cost Carve-Out. BANKRUPTCY CODE means Title 11 of the United States Code, as from time to time amended. BANKRUPTCY COURT means the United States Bankruptcy Court for the Central District of California. BLOCKED ACCOUNT AGREEMENT means an agreement between the Borrower, CITBC and the depositary bank for the Concentration Account, either substantially in the form of Exhibit A hereto or in such other form and upon such other terms and conditions as may be satisfactory to CITBC. BORROWER is defined in the preamble hereto. BORROWING BASE means, at any time of determination, an amount equal to the lesser of (i) 60% of the then Eligible Inventory, valued on a FIFO basis at the amount reflected at such time in the "stock ledger report" maintained by the Borrower as part of its perpetual inventory system in accordance with its ordinary practice prior to the Petition Date or, if less, at the lower of (x) the Borrower's actual cost thereof, determined without duplication net of all discounts, allowances and capitalized costs for receipt, unpacking, handling, distribution or shipment to stores or (y) the market value thereof, and (ii) 36.5% of the then Eligible Inventory, valued at the ticketed price as reflected in the Borrower's stock ledger report so maintained, as such percentages may be reduced pursuant to clause N in Section 2. BUSINESS DAY means any day on which both CITBC and Chemical Bank are open for business. CAPITAL EXPENDITURES means, for any period, the aggregate of all expenditures made by the Borrower or any Guarantor during such period that in conformity with GAAP are required to be added to or reflected by its "property, plant and equipment" account or any similar fixed asset account on its balance sheet. CAPITAL LEASE means any lease of property (whether real, personal or mixed) which, in conformity with GAAP, is accounted for as a capital lease or a Capital Expenditure on the balance sheet of the Borrower. 3 5 EXECUTION COPY CASE COST CARVE-OUT means cash proceeds of Inventory, not exceeding $500,000 in the aggregate, released or deposited by CITBC after termination of this Financing Agreement as set forth in Section 9.8. CASE COSTS means (a) fees and expenses of professionals (including, without limitation, attorneys, accountants, appraisers, brokers, and consultants) employed at the expense of the Borrower's or any Guarantor's bankruptcy estate on behalf of any Person (including, without limitation, the Borrower, any Guarantor, any official committee, any trustee or examiner), (b) fees and expenses of any trustee or examiner appointed in any of the Cases, and (c) fees and expenses reimbursable to any creditor of the Borrower or any Guarantor or other party in interest in any of the Cases, including, without limitation, fees or expenses of the kind specified in Section 503(b)(3) and (4) of the Bankruptcy Code. CASES includes each of the bankruptcy cases identified as Case Nos. SA95-22533-JW through SA95-22538-JW pending in the Bankruptcy Court and specifically includes each Chapter 7 case to which any such bankruptcy case may be converted and all other successor proceedings. CHEMICAL BANK RATE means the rate of interest per annum announced by Chemical Bank from time to time as its prime rate in effect at its principal office in the County, City and State of New York. (The prime rate is not intended to be the lowest rate of interest charged by Chemical Bank to its borrowers). CITBC is defined in the preamble hereto. CLAIM is used as defined in the Bankruptcy Code. COMMITMENT LETTER means the letter dated December 8, 1995 addressed to the Borrower by CITBC and accepted by the Borrower. CONCENTRATION ACCOUNT means any demand deposit account with Bank of America, NT&SA, Chemical Bank or any other bank reasonably satisfactory to CITBC that is subject to a Blocked Account Agreement and used by Borrower, with CITBC's express written consent, to receive funds transferred from any Store Account. CONFIRMATION ORDER means an order confirming a plan in the Borrower's Case or in any Guarantor's Case. CONTINGENT INDEMNIFICATION OBLIGATIONS means all Obligations for indemnification enforceable by CITBC under any of the Loan Documents (including, without 4 6 EXECUTION COPY limitation, Obligations arising under Section 4.3, 6.5, 10 or 11.12), in respect of which, at the time of determination, no claim has accrued or been made. CONTINUING means (i) with reference to any event which is a Default, that the act, omission or other event constituting such Default occurred, was not cured or corrected, so as to eliminate such Default to CITBC's written satisfaction in the exercise of its reasonable business judgment during any period of grace provided in Section 9.1, and has not been waived by CITBC in writing, and (ii) with reference to any event which is an Event of Default, that such event occurred and has not been waived by CITBC in writing. DEFAULT means any event which would become an Event of Default upon the giving of any notice, the lapse of any period of time or the satisfaction of any condition described in Section 9.1 or required to be given, lapsed or satisfied under Section 9.1. DEFAULT RATE OF INTEREST means a rate of interest per annum equal to the sum of (i) three percent (3%) per annum and (ii) the Chemical Bank Rate, which rate CITBC shall be entitled to charge on all Obligations when and as provided in Section 9.3. DISCHARGE OF THE FINANCING means that the obligation of CITBC to extend credit under this Financing Agreement has been terminated, all outstanding Letters of Credit have expired or have been honored, surrended or otherwise discharged, and all outstanding Obligations, except Contingent Indemnification Obligations, have been indefeasibly paid in full in cash. DOCUMENTATION FEE means CITBC's fees relating to any and all modifications, waivers, releases, amendments or additional collateral with respect to this Financing Agreement or the Obligations. EBITDA means, for any specified accounting period, an amount equal to (i) the consolidated net income of The Clothestime, Inc. and its Subsidiaries for such period, determined and consolidated in accordance with GAAP applied on a basis consistent with those applied in the January 28, 1995 audited financial statements of The Clothestime, Inc., plus (ii) to the extent deducted in determining such net income, all (x) Interest Expense, tax expense, depreciation expense and amortization expense, each determined and consolidated in accordance with GAAP on a basis consistent with such January 28, 1995 audited financial statements, and (y) all non-cash charges required under GAAP by reason of the reorganization or restructuring of The Clothestime, Inc. and its Subsidiaries, minus (iii) to the extent counted in determining such net income, all non-cash revenues and income items required under GAAP by reason of such reorganization or restructuring, and minus (iv) all Case Costs incurred or accrued during such period (based on billings submitted and claims made, whether 5 7 EXECUTION COPY or not allowed by the Bankruptcy Court) that were not counted as charges in determining such net income. ELIGIBLE INVENTORY means, at any time of determination, Inventory of the Borrower which conforms to the warranties herein, is owned by the Borrower free and clear of all liens (including Letter of Credit Liens other than Letter of Credit Liens granted to the Issuing Bank and enforceable by CITBC) and consists of clothing and accessories that are finished goods held for sale, and that are merchantable and readily saleable to, the public in the ordinary course of the Borrower's business, less any and all reserves required by CITBC from time to time in its good faith credit judgment (without duplication and with due allowances for any like reserves previously taken into account by the Borrower in valuing the Inventory on its stock ledger report) for (i) supplies, (ii) Inventory not located in the United States of America or Puerto Rico, (iii) Inventory returned or rejected by the Borrower's customers other than Inventory that is undamaged and resalable in the normal course of business, (iv) Inventory to be returned to the Borrower's suppliers, (v) Inventory in transit to third parties, (vi) Inventory not reflected in the Borrower's stock ledger report, (vii) Inventory offered for sale at below cost, (viii) special orders, (ix) market value declines, (x) shrinkage, (xi) bill and hold (deferred shipment or consignment sales), (xii) markdowns, (xiii) goods not in the possession of the Borrower at its retail store locations, in its distribution center or in its trucks, (xiv) demonstration items, (xv) damaged or defective goods, (xvi) goods held by the Borrower in inventory for more than 180 days, (xvii) goods in transit with carriers, (xviii) goods imported or delivered under any outstanding letter of credit, including any Letter of Credit, but only for as long as any the letter of credit or any Letter of Credit Lien remains outstanding, and (xix) reclamation claims in respect of which an order has been entered in the Borrower's Case, or a motion for an order has been served or filed therein, requiring or permitting the seller of any goods delivered to or received by the Borrower prior to the Petition Date to reclaim or recover any such goods or any proceeds thereof. ERISA means the Employee Retirement Income Security Act of 1974, as amended from time to time and the rules and regulations promulgated thereunder from time to time, as applicable. EVENT OF DEFAULT means any of the events described in Section 9.1. EXCLUDED PROCEEDS means proceeds of Inventory that (i) were received from sales made by the Borrower prior to the Petition Date, (ii) did not on the Petition Date or at any time thereafter constitute or take the form of Inventory, and (iii) are subject to a lien granted to a Pre-Petition Secured Creditor prior to the Petition Date or are required to be deposited to a segregated bank account or paid to Wells Fargo, as agent, pursuant to the Wells Fargo Stipulation and Order. 6 8 EXECUTION COPY FINAL APPROVAL ORDER means an order of the Bankruptcy Court including the provisions of the Interim Approval Order, appropriately modified so as to grant final approval of the financing contemplated hereby, up to the full amount of the Line of Credit, and further including such other provisions as CITBC may request and otherwise in all respects satisfactory to CITBC and the Borrower. GAAP means generally accepted accounting principles in the United States of America as in effect from time to time and for the period as to which such accounting principles are to apply. Except as otherwise provided in this Financing Agreement, all computations and determinations as to accounting or financial matters and all quarterly and annual consolidated financial statements to be delivered pursuant to this Financing Agreement shall be made and prepared in accordance with GAAP (including principles of consolidation where appropriate) as in effect on the date hereof and as applied by the Borrower in the preparation of its audited financial statements for its fiscal year ended January 28, 1995, and all accounting or financial terms shall have the meanings ascribed to such terms by GAAP. GOOD FAITH means honesty in fact in the conduct or transaction concerned, without regard to whether the conduct or transaction is consistent with any usage of trade or standards considered commercially reasonable by others and without any requirement that any prior course of performance or course of dealing be maintained. GUARANTOR is defined in the preamble hereto. GUARANTY means a Guaranty in favor of CITBC, in substantially the form of Exhibit B hereto. INDEBTEDNESS means all liabilities, contingent or otherwise, that are (i) obligations in respect of borrowed money or evidenced by notes, bonds or any other instrument or debt security, (ii) obligations for the deferred purchase price of property, services or assets, other than goods and services acquired in the ordinary course of business on customary trade terms, (iii) liabilities in respect of letters of credit, and (iv) lease obligations which, in accordance with GAAP, have been or should be capitalized. INTEREST EXPENSE means, for any accounting period, (i) the Borrower's total interest charges for such period determined in accordance with GAAP on a basis consistent with the Borrower's most recent audited financial statements, but in any event excluding amortization of the Loan Facility Fee and closing costs related to this Financing Agreement, minus (ii) the Borrower's interest income for such period. 7 9 EXECUTION COPY INTERIM APPROVAL ORDER means an order of the Bankruptcy Court in form and substance as set forth in Exhibit C hereto or with such changes therein as may be approved in writing by CITBC and the Borrower. INVENTORY has the meaning given to it in Division 9 of the California Uniform Commercial Code. INVENTORY MANAGEMENT FEE means a fee of $30,000 per each six month period, commencing with the six month period beginning on the date the Interim Approval Order is entered, which shall be paid to CITBC in accordance with Section 7.7 as compensation for otherwise unreimbursable costs incurred by CITBC in connection with record keeping, periodic examinations and analyzing and evaluating the Inventory. ISSUING BANK means any bank issuing a Letter of Credit. LETTER OF CREDIT means a letter of credit issued with the assistance of CITBC for account or at the request of the Borrower. LETTER OF CREDIT GUARANTY means any guaranty, joint application or other undertaking delivered by CITBC to an Issuing Bank relating to the Borrower's obligation to reimburse the Issuing Bank for payments made under a Letter of Credit or for interest thereon or for any other amounts payable to the Issuing Bank under any application or agreement relating to such Letter of Credit. LETTER OF CREDIT GUARANTY FEE means the fee CITBC charges under Section 7.2 for issuing a Letter of Credit Guaranty or otherwise aiding the Borrower in obtaining Letters of Credit pursuant to Section 4. LETTER OF CREDIT LIEN means either (i) a lien granted prior to the Petition Date upon goods shipped or to be shipped to the Borrower under a pre-petition commercial letter of credit, or upon documents of title covering such goods, enforceable solely by the issuing bank on such letter of credit and securing solely the Borrower's obligation to reimburse the issuing bank for drawings made under such letter of credit to cover the purchase price of such goods, but only if such lien is released and discharged when the issuing bank is so reimbursed and is released and discharged at such time even if the reimbursement obligation was or is converted into or repaid from the proceeds of any loan made by the issuing bank or was or is converted into a bankers acceptance or any other form of obligation owed to the issuing bank, and (ii) any lien granted to an Issuing Bank, with CITBC's consent, and enforceable by CITBC under the application or agreement relating to any Letter of Credit. 8 10 EXECUTION COPY LIBOR means, at any time of determination and subject to availability, the London Interbank Offered Rate paid in London by Chemical Bank on one month, two month, three month, or six month dollar deposits and if such rates are not otherwise available, then those rates as published, under "Money Rates", in the New York City edition of the Wall Street Journal or if there is no such publication or statement therein as to Libor, then in any publication used in the New York City financial community. LIBOR LOAN means a Revolving Loan for which the Borrower has elected to use Libor for interest rate computations. LIBOR PERIOD means the interest period for a Libor Loan, determined for one month, two month, three month or six month dollar deposits, as selected by the Borrower. LIEN is used as defined in the Bankruptcy Code. LINE OF CREDIT means $40,000,000 or any lesser amount, in $5,000,000 increments, to which the Borrower may elect to reduce such amount by giving CITBC at least five days' written notice thereof. Once reduced by the Borrower, such amount may not be increased, except as agreed in writing by CITBC. LINE OF CREDIT FEE means the fee due CITBC at the end of each month for the Line of Credit and shall be determined for any month by multiplying (i) 0.375% per annum, for the number of days in such month during which this Financing Agreement was in effect, based on a 360-day year, by (ii) the difference between (A) the average daily amount of the Line of Credit for each such day and (B) the sum of (x) the average daily balance of outstanding Revolving Loans and other charges to the Borrower's loan account for each such day, but counting as a -0- each day on which there was a credit balance in the Borrower's loan account, and (y) the average daily undrawn amount available under outstanding Letters of Credit for each such day. LOAN DOCUMENTS means this Financing Agreement, the Guaranty, the Blocked Account Agreement, the Approval Orders, each instrument, agreement, document, certificate or report delivered by the Borrower or any Guarantor pursuant to this Financing Agreement or in connection with the financing transaction contemplated hereby and each other document in any manner relating thereto. LOAN FACILITY FEE means the fee payable to CITBC in accordance with, and pursuant to, the provisions of Section 7.6. OBLIGATIONS means all indebtedness, liabilities and obligations of the Borrower and the Guarantors to CITBC and others set forth in or arising under or in respect of this Financing Agreement, the Guaranty, the Blocked Account Agreement or any other 9 11 EXECUTION COPY Loan Document, as the same may from time to time be amended and in effect, and all other debts, liabilities and obligations of every type and description in any manner related to this Financing Agreement or any other Loan Document, at any time created or incurred by the Borrower or any Guarantor and enforceable by CITBC, including (without limitation) (i) all loans and advances at any time made by CITBC to the Borrower or to others for the Borrower's account, (ii) all reimbursements owed to an Issuing Bank or CITBC (or both of them) for any payment made under any Letter of Credit and all reimbursements owed to CITBC for any payment made under any Letter of Credit Guaranty and all other obligations in respect of any Letter of Credit or Letter of Credit Guaranty, (iii) all other obligations for credit extended or financial accommodations provided by CITBC to the Borrower or to others for the Borrower's account, (iv) all interest and fees owed to CITBC, (v) all Out-of-Pocket Expenses and other expense reimbursements owed to CITBC or to others for CITBC's account, and (vi) all indemnification obligations; PROVIDED, HOWEVER, that no liability at any time owed by the Borrower to any Affiliate of CITBC on account of factored or financed receivables arising from the sale of goods to the Borrower shall be included among the Obligations. OFFICIAL COMMITTEE means the Official Committee of Unsecured Creditors in the Borrower's Case. OUT-OF-POCKET EXPENSES means all of CITBC's costs and expenses incurred relative to (i) the Commitment Letter and any supplements and amendments thereto, (ii) the preparation, negotiation or closing of this Financing Agreement, the Guaranty, each Blocked Account Agreement and each other Loan Document (whether incurred prior to or at any time after the date of this Agreement), (iii) the making of Revolving Loans, issuance of Letters of Credit or Letter of Credit Guaranties, administration of CITBC's rights and remedies (except CITBC's internal cost of inspecting or auditing the Borrower's Inventory at any time when no Default or Event of Default is Continuing), or any amendment, modification or waiver thereof, (iv) the collection of the Obligations or the exercise or enforcement of any right or remedy relating to the Obligations or the collection thereof, (v) any claim, litigation or proceeding in any manner relating to this Financing Agreement or the transactions contemplated hereby, and (vi) the Cases or any motion or adversary proceeding therein or the protection of CITBC's rights, remedies and interests in any of the Cases, and shall include, without limitation, the reasonable fees and expenses of CITBC's legal counsel, the cost of record searches, all costs and expenses incurred by CITBC in opening bank accounts, depositing checks, receiving and transferring funds, and any charges imposed on CITBC due to "insufficient funds" of deposited checks and CITBC's standard fee relating thereto, any amounts paid by CITBC to an Issuing Bank or incurred by or charged to CITBC by the Issuing Bank under any Letter of Credit Guaranty or the Borrower's reimbursement agreement, application for letter of credit or other like 10 12 EXECUTION COPY document which pertains either directly or indirectly to any Letter of Credit, CITBC's standard fees relating to the Letters of Credit and any drafts thereunder, reasonable local counsel fees and expenses, if any, fees and taxes relative to the filing of financing statements, and all expenses, costs and fees incurred in connection with the sale or liquidation of the Borrower's Inventory and the collection of the proceeds thereof. PERMITTED INVESTMENTS means (i) commercial paper issued or guaranteed by a Person rated P-1 or better by Moody's Investors Service, Inc. or A-1 or MIG-1 or better by Standard & Poor's Corporation, (ii) deposits maturing within six months issued by any commercial bank which is a member of the Federal Reserve System and has a combined capital and surplus and undivided profits of not less than $100,000,000, (iii) repurchase agreements having maturities of not more than six months secured by readily marketable direct obligations of the United States of America or any agency thereof, (iv) readily marketable obligations of the United States of America or any agency thereof, maturing within six months, and (v) mutual funds regularly traded in the United States of America whose investments are limited to those described in clauses (i) through (iv) above. PERSON means an individual, partnership, corporation, business trust, joint stock company, trust, debtor in possession, unincorporated association, joint venture, governmental authority or other entity of whatever nature. PETITION DATE means December 8, 1995 at 3:15 p.m., Pacific time. PRE-PETITION CLAIM PAYMENT means each and every return of goods on account of a pre-petition claim, return of goods on account of reclamation rights and payment in lieu of reclamation rights, adequate protection payment to a secured creditor, payment of pre-petition taxes, trusts, fees or impositions and each other payment or distribution or recovery of property, of any and every type and description, made on account of any claim against the Borrower or any Guarantor at any time after the Petition Date, except (i) the allowed and allowable administrative expenses of the Cases, other than reclamation claims, (ii) payment of wages and other employee benefits and customer refunds and store credits authorized to be paid or honored under the order of the Bankruptcy Court entered in the Cases on December 8, 1995, (iii) payment of a reclamation claim that has been allowed as an administrative expense in the Borrower's Case, if such payment is made in cash, (iv) the cash payments to Wells Fargo and segregated cash deposits for the benefit of Wells Fargo that are required to be made by the Borrower or any Guarantor, and the letters of credit and related reimbursement obligations that are required to be delivered to Wells Fargo, under the Wells Fargo Stipulation and Order, (v) a Proceeds Payment, if and to the extent the Bankruptcy Court has found and ordered, upon adjudication and not upon settlement, 11 13 EXECUTION COPY that Wells Fargo has a valid, enforceable and non-avoidable lien on the proceeds used to make such payment and such order has not been reversed or set aside and no appeal therefrom is pending, and (vi) a Proceeds Settlement Payment. PRE-PETITION CLAIM PAYMENT BASKET means $500,000. PRE-PETITION SECURED CREDITOR means Wells Fargo, individually or as agent, Union Bank and each other creditor that holds any lien granted or arising prior to the Petition Date enforceable against any property of the estate in any of the Cases. PROCEEDS PAYMENT means a payment (other than a payment required to be made under the Wells Fargo Stipulation and Order) made to Wells Fargo, as agent, upon authorization from the Bankruptcy Court from the cash proceeds of any tax refund or any other asset (other than money) of the Borrower or any Guarantor (except Inventory) that is not necessary or useful in the conduct of the Borrower's business or for a successful reorganization, upon which Wells Fargo, as agent, claims a lien pursuant to one or more of the security agreements executed and delivered by the Borrower or any Guarantor prior to the Petition Date. PROCEEDS SETTLEMENT PAYMENT means a Proceeds Payment made pursuant to a settlement, approved by the Bankruptcy Court, of any dispute between the Borrower and Wells Fargo as to whether Wells Fargo holds a lien upon the proceeds used to make such Proceeds Payment. PROCEEDS SETTLEMENT PAYMENT RESERVE means, at any time of determination, an amount equal to all Proceeds Settlement Payments made at or prior to such time, except any Proceeds Settlement Payment made with CITBC's prior written consent. REAL ESTATE means any real estate in which the Borrower or any Guarantor owns any fee or leasehold interest. REPORTING DATE means any date on which the Borrower is to deliver to CITBC any financial statement or any other information that is to be delivered by, or that may be requested from, the Borrower pursuant to the terms of this Financing Agreement. RETAINED CASH means cash necessary to stock the Borrower's cash registers at its retail locations, petty cash for its chief executive office and, if and so long as no Default or Event of Default is Continuing, cash (not exceeding $1,000,000 in the aggregate) left in Store Accounts, all in amounts consistent with the Borrower's historic business practice. 12 14 EXECUTION COPY REVOLVING LOANS means the loans and advances made, from time to time, to or for the account of the Borrower by CITBC pursuant to Section 3.1. SECOND TIER SUPERPRIORITY CLAIM is used as defined in the Wells Fargo Stipulation and Order and refers solely to the Second Tier Superpriority Claims expressly required to be granted thereunder. SPECIAL PAYMENTS means, for any day of determination, all funds that were previously received by CITBC and credited to the Borrower's loan account or otherwise applied to the payment of any Obligations, if and to the extent (i) such funds are reasonably believed by CITBC to be the proceeds of any property other than Inventory, unless either (x) CITBC is satisfied that such property and such proceeds were owned by the Borrower free and clear of any and all liens and interests or (y) CITBC has agreed, at the time such funds were received by it or at any other time, that such proceeds shall not constitute Special Payments, or (ii) such funds are the subject of any pending or overtly threatened motion, proceeding or litigation by any Pre-Petition Secured Creditor asserting or alleging a lien or interest in such funds, even if such lien or interest is denied by the Borrower, unless such lien or interest has either (x) been forever released and discharged in writing by such Pre-Petition Secured Creditor or (y) been determined not to exist or not to be enforceable by a final and nonappealable order of a court of competent jurisdiction. SPECIAL PAYMENTS RESERVE means, for any day of determination, any amount that is equal to or less than the then amount of all Special Payments and that is established for such day by CITBC, at CITBC's sole option (without being bound by the amount, if any, so established for any previous day and without any obligation to establish any such amount for any day). STORE ACCOUNT means a deposit account to which cash receipts from the sale of Inventory are deposited by the Borrower. STORE CLOSING PROGRAM means the closing of 137 of the Borrower's retail stores as set forth in the Borrower's motion relating thereto filed December 12, 1995 and the closing of additional stores from time to time in a comparable manner, so long as the Borrower continues to operate at least 275 retail stores. SUBSIDIARY means, as to any Person, any Person or entity of which shares of stock or other ownership interest having ordinary voting power (other than stock or such other ownership interests having such power only by reason of the happening of a contingency) to elect a majority of the board of directors or other managers are at the time owned, or the management of which is otherwise controlled, directly or indirectly through one or more intermediaries, or both, by such Person. 13 15 EXECUTION COPY SUPER-PRIORITY STATUS means that any liability of the Borrower or any Guarantor, whether arising from a pre-petition claim or an administrative expense or other debt, liability or obligation incurred after the Petition Date, is granted or becomes entitled in any of the Cases to priority over any or all administrative expenses of the kind specified in Sections 503(b) or 507(b) of the Bankruptcy Code and, when used in reference to the Obligations, means that CITBC has an allowed administrative expense claim in respect of each and all of the Obligations at any time incurred, arising or outstanding with priority over all such administrative expenses (whether incurred prior to or after the conversion of any Case to a Chapter 7 case or in any other successor or related proceeding), over all priority claims and over all other claims against any of the Debtors or the estate in any of the Cases, whenever incurred, subject only to the Case Cost Carve-Out. TERMINATION DATE means the earliest to occur of (i) December 8, 1997, (ii) the effective date of a plan in any of the Cases, (iii) the date on which any Case is dismissed or converted to a Case under Chapter 7 of the Bankruptcy Code, (iv) the date on which any Approval Order is vacated, reversed, set aside or (except as may be satisfactory to CITBC) modified or amended, (v) the date on which the Borrower voluntarily reduces the Line of Credit to zero and terminates CITBC's obligation to extend credit under this Financing Agreement, and (vi) the date on which CITBC terminates its obligation to extend credit under this Financing Agreement after the occurrence of an Event of Default. U.S. TRUSTEE FEES means fees payable, in respect of any of the Cases, to the United States Trustee pursuant to 28 U.S.C. Section 1930(a)(6). WELLS FARGO means Wells Fargo Bank, National Association. WELLS FARGO STIPULATION AND ORDER means the Amended Stipulation for Order dated December 28, 1995, and the Order thereon, attached as Exhibits D-1 and D-2 hereto, respectively, as originally in effect and as amended from time to time with CITBC's prior written consent, and does not include the stipulation for order, and order thereon, entered in the cases on December 18, 1995, as docket entries 49-1 and 50-1. References herein to a "Section," when not further identified by reference to any law or agreement, are references to the Sections of this Financing Agreement. SECTION 2. CONDITIONS PRECEDENT 14 16 EXECUTION COPY The obligation of CITBC to make any Revolving Loan or to assist the Borrower in obtaining any Letter of Credit or issue any Letter of Credit Guaranty shall be in all respects subject to the continuing satisfaction, at the time any Revolving Loan is to be made or any Letter of Credit or Letter of Credit Guaranty is to be issued, of each of the following conditions precedent: a. CORPORATE ORGANIZATION. CITBC shall have received (i) a copy of the Certificate of Incorporation of the Borrower and each Guarantor as then in effect, certified by the Secretary of State of its incorporation, and (ii) a copy of the By-Laws of the Borrower and each Guarantor, as then in effect, certified by its Secretary or Assistant Secretary. b. BOARD RESOLUTION. CITBC shall have received a copy of resolutions of the Board of Directors of the Borrower and each Guarantor, authorizing the commencement of the Cases and the execution, delivery and performance of this Financing Agreement, the Guaranty, the Blocked Account Agreement and any and all related matters, certified by its Secretary or Assistant Secretary, as of the date hereof, together with a certificate of the Secretary or Assistant Secretary of the Borrower and each Guarantor as to the incumbency and signature of the officers of the Borrower and each Guarantor executing this Financing Agreement and any and all other Loan Documents or authorized to act hereunder, together with evidence of the incumbency of such Secretary or Assistant Secretary; and such resolutions and certificate shall remain in full force and effect and shall not have been subsequently amended or modified. c. OFFICER'S CERTIFICATE. CITBC shall have received, at the first funding of Revolving Loans and from time to time thereafter if CITBC so requests, an executed Officer's Certificate of the Borrower and each Guarantor, satisfactory in form and substance to CITBC, certifying that (i) the representations and warranties contained herein are true and correct in all material respects on and as of the date hereof, (ii) each of the Borrower and the Guarantors is in compliance with all of the other terms and provisions set forth herein, (iii) the Revolving Loans or Letters of Credit then requested by the Borrower do not exceed the then Availability, and (iv) no Default or no Event of Default has occurred and is then Continuing. d. THE CASES. CITBC shall have received such evidence as it may from time to time request confirming that (i) the Cases have been voluntarily commenced by the Borrower and the Guarantors under Chapter 11 of the Bankruptcy Code, (ii) none of the Cases has been dismissed or converted to a case under any other Chapter of the Bankruptcy Code, and proceedings have not been suspended in any of the Cases, (iii) an order directing joint administration of the Cases has been entered and remains in effect therein, (iv) the debtor in each of the Cases remains as 15 17 EXECUTION COPY debtor in possession and retains the full authority granted to it under the Bankruptcy Code to exercise the rights and powers, and perform the functions and duties, of a trustee therein, (v) no trustee or examiner with expanded powers has been appointed in any of the Cases, and (vi) no order has been entered in any of the Cases (x) limiting the right, power, authority or ability of the Borrower to sell any of its Inventory, to deposit the proceeds of Inventory (other than Excluded Proceeds) in the Concentration Account or in Store Accounts for immediate remittance to the Concentration Account, to deliver to CITBC all amounts deposited to the Concentration Account at any time after the Petition Date, as soon as good funds are available, and any and all other proceeds of Inventory (other than Excluded Proceeds), to repay any of the Obligations, or to perform any of its obligations under this Financing Agreement and any Blocked Account Agreement or (y) limiting, in any respect determined by CITBC in good faith to be materially adverse to the Borrower or to the Borrower's ability to conduct its business, repay the Obligations or reorganize successfully in its Case, the right, power, authority or ability of the Borrower to operate its business, to manage its affairs, or to possess, occupy or operate its retail stores. e. CASH COLLATERAL. Either (i) the debtors in the Cases shall not have used, at any time since the Petition Date, any Pre-Petition Secured Creditor's cash collateral or (ii) the terms and conditions on which any Pre-Petition Secured Creditor has given consent to use of its cash collateral, or the Bankruptcy Court has approved the use of any Pre-Petition Secured Creditor's cash collateral, shall have been approved in writing by CITBC. f. RECLAMATION RIGHTS. No Inventory shall have been taken from or returned by the Borrower on account of any reclamation claim, and no order authorizing or permitting any such taking or return shall have been entered in the Borrower's Case. g. MERCHANDISE RETURNS. No order shall have been entered in any of the Cases authorizing any return of merchandise for credit to pre-petition claims pursuant to Section 546(g)* of the Bankruptcy Code, except for (i) any return of defective merchandise that was not at any time included in the Borrowing Base and (ii) any return that, when counted (at the purchase price of the goods) as a Pre-Petition Claim Payment and added to all other Pre-Petition Claim Payments, would not cause the Pre-Petition Claim Payment Basket to be exceeded. h. NO OTHER LIENS; WELLS FARGO STIPULATION AND ORDER. CITBC shall have received such assurances as may be satisfactory to it and its counsel (including, if required by CITBC, a release by each Pre-Petition Secured Creditor of any and all liens and perfection notices) that no lien granted or created prior to the 16 18 EXECUTION COPY Petition Date is or ever will be attached to or enforceable against any Inventory held by the Borrower on the Petition Date or acquired by the Borrower at any time thereafter or any proceeds of such Inventory (other than Excluded Proceeds) or any cash deposited to any Store Account or to the Concentration Account at any time after the Petition Date (except segregated cash, constituting Excluded Proceeds, required to be kept segregated under the Wells Fargo Stipulation and Order); and the Wells Fargo Stipulation and Order shall have been duly executed and delivered by Wells Fargo and by the Borrower and each Guarantor (in the case of the stipulation) and entered by the Bankruptcy Court (in the case of the order thereon), shall have become effective in accordance with its terms and shall remain in full force and effect, enforceable in accordance with its original terms and any changes therein that have been approved in writing by CITBC. i. APPROVAL ORDERS. At the time of the making of the initial Revolving Loans, or at the time of the issuance of the initial Letter of Credit, whichever first occurs, CITBC shall have received a certified copy of the Interim Approval Order, which shall have been entered in each of the Cases, upon consent of Wells Fargo, and the Interim Approval Order shall not at any time thereafter have been vacated, reversed or (except as may be satisfactory to CITBC) modified or amended in any respect, and its effectiveness shall not then be stayed. No later than January 31, 1996, CITBC shall have received a certified copy of the Final Approval Order, which shall have been entered in each of the Cases, upon consent of Wells Fargo, and the Final Approval Order shall not at any time thereafter have been vacated, reversed or (except as may be satisfactory to CITBC) modified or amended in any respect, and its effectiveness shall not then be stayed. j. FINANCING AGREEMENT; GUARANTY. This Financing Agreement shall have been duly executed and delivered by the Borrower and each Guarantor; the Guaranty shall have been duly executed and delivered by each Guarantor; neither the Borrower nor any Guarantor shall have repudiated or contested any agreement made by it in this Financing Agreement or the Guaranty; and the Financing Agreement and the Guaranty shall be and remain the lawful obligation of the Borrower and the Guarantors and the estates in the Cases, enforceable in accordance with their respective terms. k. BLOCKED ACCOUNT AGREEMENT. No later than January 31, 1996, the Borrower shall have opened the Concentration Account and executed and delivered to CITBC a Blocked Account Agreement covering the Concentration Account, signed by the depositary bank for the Concentration Account, and the Borrower's cash receipts from the sale of Inventory (including credit card sales but excluding Excluded Proceeds) shall at all times thereafter have been remitted, either directly or through the Store Accounts, to the Concentration Account and the Blocked Account Agreement 17 19 EXECUTION COPY shall at all times thereafter have remained in full force and effect and been performed by the parties thereto in accordance with its terms. l. CREDIT CARD ARRANGEMENTS. No later than the date on which the Final Approval Order is entered, the Borrower shall have given all directions necessary to cause all of its cash receipts from credit card sales made at any time after the Petition Date to be remitted directly to the Concentration Account. m. CASUALTY INSURANCE. No later than the date on which the Final Approval Order is entered, the Borrower shall have delivered to CITBC evidence satisfactory to CITBC that casualty insurance policies listing CITBC as loss payee, with respect to insurance proceeds relating to Inventory, are in full force and effect, all as set forth in Section 6.3. n. INVENTORY REVIEW. CITBC shall have received (i) prior the date on which the first Approval Order is entered, a report from Gordon Bros. Partners, Inc. relating to the Borrower's inventory and the value thereof, and (ii) from time to time thereafter, such supplemental reports as CITBC may request pursuant to Section 5.7. Each such report shall be in all respects satisfactory to CITBC. If CITBC determines, in its commercially reasonable judgment, that a reduction in the Borrowing Base is warranted based on the information, valuation and opinions set forth in any such report, the Borrower and the Guarantors shall have agreed to such reduction. o. OPINION. Counsel for the Borrower and Guarantors shall have delivered to CITBC an opinion in the form attached hereto as Exhibit E hereto; and CITBC shall not thereafter have been advised by its counsel that, by reason of any subsequent change in law, order in any of the Cases or any other legal or factual development, CITBC should not continue to rely on any matter confirmed in such opinion of counsel. p. NO MATERIAL ADVERSE CHANGE. Since December 8, 1995, no material adverse change shall have occurred in (i) the assets, liabilities, financial condition, business, operations or prospects of the Borrower or any Guarantor (other than any such change resulting from (x) the commencement of the Cases, (y) the implementation of the Store Closing Program or (z) the transactions and litigation contemplated by the Wells Fargo Stipulation and Order), (ii) the ability of the Borrower to repay the Obligations, or (iii) the enforceability of any provision in this Financing Agreement, the Guaranty, any Blocked Account Agreement, or any Approval Order. 18 20 EXECUTION COPY q. REPRESENTATIONS AND WARRANTIES. Each representation and warranty made by the Borrower or any Guarantor in this Financing Agreement shall then be true, correct and complete. r. NO DEFAULT OR EVENT OF DEFAULT. No Default or Event of Default shall have occurred and be then Continuing. s. LEGAL RESTRAINTS; LITIGATION. There shall be no order, stay, injunction, writ or other judicial or administrative restraint limiting or prohibiting the consummation of any of the financing arrangements contemplated under this Financing Agreement, the repayment of any of the Obligations, or the performance of any obligation of the Borrower and Guarantors under this Financing Agreement, the Guaranty or the Blocked Account Agreement. At the time the Interim Approval Order is entered and at the time the Final Approval Order is entered, there shall be (i) no litigation, investigation or proceeding (judicial or administrative) pending or threatened against the Borrower or any Guarantor or any of their respective assets, in any manner relating to this Financing Agreement or the financing arrangement contemplated under this Financing Agreement, except any pending or threatened appeal from an Approval Order, and (ii) no suit, action, investigation or proceeding (judicial or administrative) pending or threatened against the Borrower or any Guarantor (other than the litigation to be commenced pursuant to the Wells Fargo Stipulation and Order) or against any property of the estate in any of the Cases, which, if adversely determined, could have a material adverse effect on the business, operation, assets, liabilities, financial condition or prospects of the Borrower or any Guarantor. t. DISBURSEMENT AUTHORIZATION. The Borrower shall have delivered to CITBC all information necessary for CITBC to issue wire transfer instructions on behalf of the Borrower for the initial and subsequent Revolving Loans, including, but not limited to, disbursement authorizations in form acceptable to CITBC. u. ADDITIONAL DOCUMENTS. The Borrower shall have executed and delivered to CITBC all documents, instruments and agreements which CITBC or its counsel may reasonably deem necessary or desirable in order to consummate the lending arrangement contemplated in this Financing Agreement or in order to perform, or to provide reasonable further assurances as to the performance of, any obligation of the Borrower or any Guarantor under this Financing Agreement or any Blocked Account Agreement. v. MINIMUM AVAILABILITY. On the date of the first funding of Revolving Loans or issuance of Letters of Credit hereunder, the Availability 19 21 EXECUTION COPY remaining after all such Revolving Loans are funded and all such Letters of Credit are issued shall be at least $2,500,000. Each of the foregoing conditions shall be a continuing condition, required to be satisfied at the time each Revolving Loan is to be made hereunder and at the time each Letter of Credit or Letter of Credit Guaranty is to be issued hereunder, except that (i) any condition that is expressly required to be satisfied at or by a specific date or time need only be satisfied at or by such time and (ii) no condition that is waived by CITBC in writing need be satisfied at the time of such waiver, but unless such waiver expressly provides that it applies to future occasions such condition shall nevertheless be required to be met on each subsequent occasion on which any Revolving Loan is to be made or any Letter of Credit or Letter of Credit Guaranty is to be issued. SECTION 3. REVOLVING LOANS 3.1 FUNDING OF LOANS. Subject to the terms and conditions of this Financing Agreement, CITBC agrees to make loans and advances to the Borrower from time to time prior to the Termination Date on a revolving basis, in amounts up to the Availability determined as of such time after giving effect to all requests for loans, advances and Letters of Credit then pending. All requests for loans and advances (other than Libor Loans) must be received by an officer of CITBC no later than 2:30 p.m. New York time on the Business Day on which such loans and advances are required. CITBC shall have the right, but not the obligation, from time to time in CITBC's sole discretion to make loans and advances in excess of the then Availability, on such terms as CITBC may deem appropriate, and all such overadvances shall constitute Revolving Loans and Obligations outstanding and repayable on demand hereunder. Whenever any Default or Event of Default has occurred and is Continuing, CITBC shall not be obligated to make any Revolving Loans but may elect to do so, in its sole discretion. CITBC's election to make any such overadvances or post-default advances on one or more occasions shall not obligate it to continue doing so or to do so on any similar future occasion. 3.2 CONFIRMATION OF ELIGIBLE INVENTORY. On or before the third Business Day of each week, the Borrower shall deliver to CITBC an inventory confirmation statement, in the form of Exhibit F hereto, stating the aggregate amount of Eligible Inventory of the Borrower and the Borrowing Base as of the Friday of the immediately preceding week and executed by a responsible officer of the Borrower. CITBC shall have the right at any time, upon three Business Days' advance notice, to request such an inventory confirmation statement as of any other date. With respect to each such statement, the Borrower will provide to CITBC such additional 20 22 EXECUTION COPY information and material as CITBC may in good faith request to confirm the elements, details and manner in which the amount of the Eligible Inventory was calculated and effectively to evaluate the mix of the Inventory and such other information as CITBC may reasonably require to evaluate the Borrower's Inventory, such as returns, claims, credits, allowances. 3.3 THE INVENTORY AND ITS PROCEEDS. Each of the Borrower and the Guarantors hereby represents and warrants to CITBC, and agrees with CITBC, that (i) each sale of Inventory is, and shall be, based upon actual and bona fide sales and deliveries of Inventory in the ordinary course of business or pursuant to the Store Closing Program, and the Inventory being sold and the proceeds thereof (other than Excluded Proceeds) are the exclusive property of the Borrower and are not and shall not be subject to any co-ownership interest, lien (except a Letter of Credit Lien granted to the Issuing Bank and enforceable by CITBC), charge, arrangement, encumbrance, security interest, or financing statement whatsoever, (ii) invoices representing credit card receipts evidencing credit card sales of Inventory are in the name of the Borrower and except for disputes, offsets, defenses, counterclaims, contras, returns or credits (all arising in the normal course of the Borrower's business or except as may be promptly disclosed and acceptable to CITBC) the purchasers of such Inventory owe and are obligated to pay the amount stated in the invoices representing credit card receipts, (iii) any and all taxes and license, franchise and other governmental fees and impositions relating to the business of the Borrower or any Guarantor are the responsibility of the Borrower or such Guarantor and, except as otherwise permitted under Section 6.4, will be paid when due, and none of such taxes, fees or impositions do or will represent a lien or trust on or claim against the proceeds of any sale of Inventory or CITBC as recipient thereof, and (iv) the Borrower will promptly issue credit memoranda. 3.4 CASH RECEIPTS; APPLICATION OF FUNDS. During the term of this Financing Agreement, the Borrower may and will, at its expense, consistent with the Borrower's existing business practice or as otherwise permitted under Section 6.8C, sell its Inventory and enforce, collect and receive all amounts owing for credit card sales. Except for the Retained Cash and Excluded Proceeds, all checks or cash from the sale of Inventory will be deposited promptly to the Store Accounts and will be remitted from the Store Accounts, on a daily basis and as soon as good funds are available, to the Concentration Account. All amounts due to the Borrower for credit card sales made after the Petition Date shall be remitted by the credit card companies directly to the Concentration Account. The Borrower agrees that it will only direct the flow of funds from the Store Accounts and the credit card remitters for post-petition sales of Inventory to the Concentration Account. All amounts deposited to the Concentration Account shall be remitted to CITBC, on a daily basis and as soon as good funds are available, in accordance with the Blocked Account Agreement. All 21 23 EXECUTION COPY amounts received by CITBC from the Concentration Account shall be applied to pay outstanding Obligations and will be credited to the Borrower's loan account upon CITBC's receipt of "good funds" at its bank account in New York, New York on the Business Day of receipt if received no later than 5:00 p.m. New York time or on the next succeeding Business Day if received after 5:00 p.m. New York time. No checks, drafts or other instruments received by CITBC will constitute final payment unless and until such instruments have actually been collected. If at any time no Revolving Loans are outstanding and all other Obligations then due and charges to the Borrower's loan account have been paid, then (i) if no Default or Event of Default is then Continuing or if there are then no outstanding Letters of Credit and no outstanding Obligations (except Contingent Indemnification Obligations), CITBC shall promptly upon the Borrower's request remit any credit balance in the Borrower's loan account to the Borrower's operating account or as otherwise directed by the Borrower, and (ii) if any Default or Event of Default is then Continuing and if there are any outstanding Letters of Credit or any outstanding Obligations (except Contingent Indemnification Obligations), then CITBC may hold as cash collateral an amount equal to 105% of the maximum potential liability of the Borrower as to all outstanding Letters of Credit and all such other outstanding Obligations (except Contingent Indemnification Obligations). 3.5 THE BORROWER'S LOAN ACCOUNT. CITBC shall maintain a separate loan account on its books in the Borrower's name in which the Borrower will be charged with loans and advances and all payments by CITBC on account of any Letter of Credit or under any Letter of Credit Guaranty. CITBC shall have the right to charge and add to the Borrower's loan account any and all accrued interest, fees, Out- of-Pocket Expenses and other Obligations as they become payable by the Borrower under this Financing Agreement. The Borrower will be credited with all amounts received by CITBC from the Borrower or from others for the Borrower's account, and such amounts will be applied to payment of the Obligations. 3.6 ACCOUNT STATED. After the end of each month, CITBC shall promptly send the Borrower a statement showing the accounting for loans, advances, payments in respect of Letters of Credit, interest, fees, Out-of-Pocket Expenses and other Obligations charged to the Borrower's loan account, and all funds received by CITBC credited to the Borrower's loan account, during that month. The monthly statement shall be deemed correct and binding upon the Borrower and shall constitute an account stated between the Borrower and CITBC unless CITBC receives a written statement of any exceptions within 30 days after the date the monthly statement is mailed or delivered by CITBC. Once it becomes binding and an account stated as against the Borrower, such statement shall likewise be binding and an account stated as against each Guarantor, without any need for any separate notice or report to, or review by, any Guarantor. 22 24 EXECUTION COPY 3.7 NO COMMINGLING OF CASH COLLATERAL. The Borrower shall not commingle any cash collateral of any Pre-Petition Secured Creditor with any proceeds of Inventory generated or otherwise arising at any time after the Petition Date. No such cash collateral shall be deposited to the Store Accounts or the Concentration Accounts or (except as otherwise authorized by the Bankruptcy Court or consented to by the Pre-Petition Secured Creditor) paid over to CITBC for application to the payment of the Obligations. 3.8 CASH PAYMENTS BY THE BORROWER. CITBC may assume conclusively that all cash and cash equivalents delivered to CITBC are the sole property of the Borrower and that the Guarantors have no interest therein, except as the Borrower may otherwise specifically designate in writing at the time of, and in respect of, any particular remittance. No payment of any Obligation received by CITBC from any funds belonging to any Guarantor shall reduce the liability of such Guarantor under the Guaranty as to any and all other Obligations at any time arising or incurred. 3.9 REPAYMENT OF OVERADVANCES. If at any time, for any reason (including, without limitation, any overadvance which CITBC may have elected to make), the sum of (i) the then aggregate outstanding amount of all Obligations, except reimbursement obligations for amounts undrawn under outstanding Letters of Credit and for unreimbursed drawings under Letters of Credit, and (ii) the then amount of the Availability Reserve exceeds the lowest of (a) the Line of Credit at such time, (b) the Borrowing Base at such time, and (c) the amount then approved for borrowing hereunder by the Bankruptcy Court under the applicable Approval Order, then the Borrower shall repay such excess to CITBC immediately upon demand. 3.10 PAYMENT DUE ON TERMINATION DATE. All outstanding Obligations shall be absolutely and unconditionally due and payable in full on the Termination Date. 3.11 CITBC NOT LIABLE. CITBC shall have no obligation whatsoever to perform in any respect any contract or obligation of the Borrower or any Guarantor and shall have no liability whatsoever for any other debt, liability or obligation of the Borrower or any Guarantor. SECTION 4. LETTERS OF CREDIT In order to assist the Borrower in establishing or opening commercial Letters of Credit for the purchase of Inventory and standby Letters of Credit for any purpose in the ordinary course of the Borrower's business approved by CITBC (except 23 25 EXECUTION COPY that standby Letters of Credit shall in any event not be available (x) to support or provide adequate protection for any pre-petition claim, except for letters of credit contemplated in the Wells Fargo Stipulation and Order, (y) to provide assurance of future performance in respect of any real property lease, or (z) to support payment of any Case Costs), the Borrower has requested CITBC to join in the applications for such Letters of Credit or to guarantee payment or performance of the Borrower's obligations in respect of such Letters of Credit and any drafts or acceptances thereunder through the issuance of a Letter of Credit Guaranty, thereby lending CITBC's credit to the Borrower, and CITBC has agreed to do so. These arrangements shall be handled by CITBC subject to the terms and conditions set forth below. 4.1 ISSUANCE OF LETTERS OF CREDIT. Within the Line of Credit, and subject to the terms and conditions of this Financing Agreement, CITBC shall assist the Borrower in obtaining such Letters of Credit in an amount not to exceed the Availability at the time a Letter of Credit is requested and not to exceed $25,000,000 in an aggregate amount of Letters of Credit outstanding at any one time. No Letter of Credit shall be issued for a term in excess of one year or have an expiration date beyond December 1, 1997. CITBC's assistance with respect to Letters of Credit for amounts in excess of the limitations set forth herein shall at all times and in all respects be in CITBC's sole discretion. Whenever any Default or Event of Default has occurred and is Continuing, CITBC shall not be obligated to issue or confirm any Letter of Credit Guaranty or otherwise assist the Borrower in obtaining any Letter of Credit, but may elect to do so, in its sole discretion. 4.2 PAYMENTS TO ISSUING BANK; CHARGES TO THE LOAN ACCOUNT. CITBC shall have the right, without notice to the Borrower, (i) to pay directly to the Issuing Bank, for account of the Borrower, any amount due to the Issuing Bank as reimbursement for payments made under a Letter of Credit or for interest thereon or charges related thereto or otherwise payable to the Issuing Bank under the application or agreement relating to such Letter of Credit, and (ii) to charge the Borrower's loan account with the amount of each such payment by CITBC to the Issuing Bank and each other liability incurred by CITBC in respect of any Letter of Credit or under any Letter of Credit Guaranty both (x) whenever any payment is made by CITBC in respect of any Letter of Credit or under any Letter of Credit Guaranty and (y) in any event and whether or not any payment has been made by CITBC and whether or not CITBC's liability is then contingent, upon termination of CITBC's obligation to make loans under this Financing Agreement. Any amount so charged to the loan account shall be charged against any credit balances then in the loan account, and if there are then insufficient credit balances, then, to the extent of such insufficiency, such amount shall be deemed a Revolving Loan hereunder and shall incur interest at the rate provided for in this Financing Agreement. 24 26 EXECUTION COPY 4.3 INDEMNIFICATION. The Borrower unconditionally indemnifies CITBC and holds CITBC harmless from any and all loss, claim or liability incurred by CITBC arising from any transactions or occurrences relating to Letters of Credit established or opened for the Borrower's account, any drafts or acceptances thereunder, and all Obligations thereunder, including any such loss or claim due to any errors or actions taken by, or any omissions, negligence or misconduct of, any Issuing Bank, other than for any such loss, claim or liability arising directly and solely out of the gross negligence or willful misconduct of CITBC. The Borrower's unconditional obligation to CITBC hereunder shall not be modified or diminished for any reason or in any manner whatsoever, other than as a result of CITBC's gross negligence or willful misconduct. The Borrower agrees that any charges of the Issuing Bank incurred by CITBC for the Borrower's account shall be conclusively binding on and repayable by the Borrower and shall be charged to the Borrower's loan account. 4.4 CITBC NOT RESPONSIBLE. In connection with any Letter of Credit, CITBC shall not be responsible for the existence, character, quality, quantity, condition, packing, value or delivery of the goods purporting to be represented by any document; any difference or variation in the character, quality, quantity, condition, packing, value or delivery of the goods from that expressed in any document; the validity, sufficiency or genuineness of any documents or of any endorsements thereon, even if such documents should in fact prove to be in any or all respects invalid, insufficient, fraudulent or forged; the time, place, manner or order in which shipment is made; partial or incomplete shipment, or failure or omission to ship any or all of the goods referred to in any Letter of Credit or any document; any deviation from instructions by the beneficiary of any Letter of Credit or by the Issuing Bank; delay, default, or fraud by the beneficiary or the Issuing Bank or anyone else in connection with any goods which are the subject of any Letter of Credit or the shipment thereof; or any breach of contract between the beneficiary, shipper, vendor or Issuing Bank. Furthermore, without being limited by the foregoing, CITBC shall not be responsible for any act or omission with respect to or in connection with any goods, documents or matters which may be the subject of any Letter of Credit or for any improper honor or dishonor of any draft or demand under a Letter of Credit by an Issuing Bank. 4.5 BORROWER BOUND; CITBC'S AUTHORITY TO ACT. Any action taken by CITBC, if taken in good faith, or any action taken by any Issuing Bank, under or in connection with the Letters of Credit or any Letter of Credit Guaranty or any draft, demand or document presented, accepted or paid thereunder, shall, as between the Borrower and CITBC, be binding on the Borrower and shall not put CITBC in any resulting liability to the Borrower. Whenever any Default or Event of Default is Continuing, CITBC shall have the full right and authority to clear and resolve any questions of non-compliance of documents; to give any instructions as to acceptance or 25 27 EXECUTION COPY rejection of any documents or goods; to execute any and all steamship or airways guaranties (and applications therefor), indemnities or delivery orders; to grant any extensions of the maturity of, time of payment for, or time of presentation of, any drafts, acceptances, or documents; and to agree to any amendments, renewals, extensions, modifications, changes or cancellations of any of the terms or conditions of any of application, Letter of Credit, draft, document or acceptance, all in CITBC's sole name, and the Issuing Bank shall be entitled to comply with and honor any and all such documents or instruments executed by or received solely from CITBC, all without any notice to or any consent from the Borrower, except that CITBC shall give the Borrower notice of CITBC's acceptance or rejection of any goods. 4.6 LICENSES, TAXES AND LEGAL MATTERS. In connection with any Letter of Credit, the Borrower represents and warrants that any necessary import, export or other licenses or certificates for the import or handling of any goods will have been promptly procured and all foreign and domestic governmental laws and regulations in regard to the shipment and importation of any goods or the financing thereof will have been promptly and fully complied with, except to the extent that any such non- procurement or non-compliance will not have a material adverse effect; and any certificates in that regard that CITBC may at any time reasonably request will be promptly furnished. The Borrower further represents and warrants that all shipments made under any of the Letters of Credit shall be in accordance with the laws and regulations of the countries in which the shipments originate and terminate and are not prohibited by any such laws and regulations, except to the extent that any failure to so comply will not have a material adverse effect. The Borrower assumes all risk, liability and responsibility for, and, subject to Section 6.4, agrees to pay and discharge, all present and future local, state, federal or foreign taxes, duties, or levies. Any embargo, restriction, laws, customs or regulations of any country, state, province, city, or other political subdivision, wherein the Inventory is or may be located or payments are to be made or drafts may be drawn, negotiated, accepted, or paid, shall be solely the Borrower's risk, liability and responsibility. 4.7 CITBC'S SUBROGATION RIGHTS. Whenever any payment is made to the Issuing Bank by CITBC, CITBC shall acquire by subrogation any and all claims, liens, rights and remedies enforceable against the Borrower by the Issuing Bank or granted in any application for Letters of Credit, any standing agreement relating to Letters of Credit or otherwise, all of which shall be deemed to have been granted to CITBC and apply in all respects to CITBC and shall be in addition to all of CITBC's other claims, liens, rights or remedies. 4.8 ISSUING BANK REMAINS LIABLE. Nothing in this Section 4 is intended to relieve any Issuing Bank from any liability to any Person. 26 28 EXECUTION COPY SECTION 5. SUPER-PRIORITY STATUS; PROTECTION OF CITBC RIGHTS 5.1 OBLIGATIONS ENTITLED TO SUPER-PRIORITY STATUS. Each of the Borrower and the Guarantors hereby agrees, represents and warrants that (i) pursuant to the authority granted under Section 364(c)(1) of the Bankruptcy Code and the applicable Approval Order, all Obligations at any time incurred, arising or outstanding hereunder shall constitute allowed administrative expenses in each of the Cases, with Super-Priority Status, and (ii) any and all Second Tier Superpriority Claims granted to Wells Fargo pursuant to the Wells Fargo Stipulation and Order are in all respects subject and subordinate to the Obligations. 5.2 NO DISCHARGE; NO IMPAIRMENT OF SUPER-PRIORITY STATUS. The Borrower and the Guarantors agree that (i) the Obligations and the agreements of the Borrower and the Guarantors hereunder shall not be discharged by the entry of any Confirmation Order (and the Borrower and each Guarantor, pursuant to Section 1141(d)(4) of the Bankruptcy Code, hereby waives any such discharge) and (ii) the Super-Priority Status of the Obligations pursuant to the Approval Orders shall not be affected in any manner by the entry of any Confirmation Order. 5.3 COLLATERALIZATION PRIOR TO DISMISSAL. The Borrower and the Guarantors agree that, prior to entry of any order dismissing the Borrower's Case, the Borrower will (unless there has then been a Discharge of the Financing) take all actions necessary to grant CITBC a duly perfected and enforceable sole security interest in all of the Borrower's Inventory, whether then owned or thereafter acquired, and all proceeds of the Borrower's Inventory (except Excluded Proceeds), as security for the payment of all Obligations at any time arising. 5.4 CITBC'S RIGHTS NOT IMPAIRED. The rights granted to CITBC hereunder shall continue in full force and effect, notwithstanding the termination of this Financing Agreement or the fact that the loan account on the books of CITBC may from time to time be temporarily in a credit position, until Discharge of the Financing. No delay or omission by CITBC to exercise any right hereunder shall be deemed a waiver thereof or be deemed a waiver of any other right, and CITBC's rights may be effectively waived only in a writing signed by it. A waiver on any one occasion shall not be construed as a bar to or waiver of any right or remedy on any future occasion. 5.5 ORDER OR MANNER OF ENFORCEMENT. To the extent that the Obligations are now or hereafter secured by any assets, property or guaranty, CITBC shall have (as against the Borrower and the Guarantors and their successors and assigns and as against the estates in the Cases and in any superseding Chapter 7 case or other related or successor proceeding) (i) the right in its sole discretion to 27 29 EXECUTION COPY determine which claim, lien, right or remedy it wishes to pursue, in any order or sequence, whenever such claim, lien, right or remedy may be enforced and without any requirement (to the fullest extent that such a requirement may lawfully be waived by the Borrower and the Guarantors) that CITBC join Persons or elect its remedies, and (ii) the right at any time to pursue, enforce, sue upon, foreclose upon, relinquish, subordinate, modify or take any other action with respect to any such claim, lien, right or remedy, without in any way modifying or affecting any other claim, lien, right or remedy. 5.6 APPLICATION OF CREDIT BALANCES. Subject to Section 3.4, any and all remittances from the Concentration Account, payments, proceeds and reserves or credit balances in the Borrower's loan account at any time received or held by CITBC and, whenever any Default or Event of Default is Continuing, any other property or assets of the Borrower in the possession of CITBC may be applied by CITBC in whole or partial satisfaction of any or all of the Obligations. 5.7 REVALUATION OF INVENTORY. If the Borrower substantially changes the character, quality or mix of its Inventory, as a result of changes in its merchandising, changes in its sources of supply or otherwise, or if any other event (except implementation of the Store Closing Program) occurs that CITBC in good faith believes has adversely affected the loan value of the Borrower's Inventory, CITBC may request Gordon Bros. Partners, Inc. or any other soft-goods inventory valuation firm of nationally recognized standing to review the Inventory and related matters and prepare and deliver an inventory valuation report, satisfactory to CITBC as to scope, methodology and substance. The Borrower shall pay all costs of each such report, up to the cost of the most favorable bid received for such report from any such nationally recognized firm. CITBC may request such a report (i) at any time or from time to time after any Default or Event of Default has occurred, whether or not such Default or Event of Default is Continuing, (ii) upon, or at any time after, each occasion when, for at least five consecutive Business Days, the Availability was less than (x) $100,000, for days between January 15 and May 31, and (y) $2,500,000, at any other time, and (iii) in any event at least once each year. 5.8 NO CONFLICTING AGREEMENTS, ORDERS OR ACTIONS. Each of the Borrower and the Guarantors covenants and agrees that it will not enter into any stipulation or agreement, request or permit or suffer itself to become subject to any order entered in any of the Cases, or take or permit any other Person to take any other action which does or could conflict or materially interfere with any of the rights, privileges, benefits and remedies of CITBC under this Financing Agreement, the Guaranty, the Blocked Account Agreement, the Wells Fargo Stipulation and Order or the Approval Orders or materially diminish or impair the practical realization of any such right, privilege, benefit or remedy. This Section 5.8 does not restrict or limit the 28 30 EXECUTION COPY execution and delivery of the Wells Fargo Order and Stipulation by the Borrower and the Guarantors or the performance of any of their obligations thereunder. SECTION 6. REPRESENTATIONS, WARRANTIES AND COVENANTS 6.1 TITLE TO INVENTORY. Each of the Borrower and Guarantors hereby represents and warrants to CITBC, and covenants with CITBC that, on the date of this Financing Agreement and at all times hereafter until Discharge of the Financing, (i) all merchandise at any time located in any of the retail stores or the distribution center operated by the Borrower and all other Inventory described or reflected in the Borrower's perpetual inventory system or books and records or in any report or financial statement at any time delivered to CITBC by or on behalf of the Borrower or any Guarantor is and will be purchased and owned solely by and in the name of the Borrower, and none of the Guarantors have or will have any interest therein, and (ii) the Borrower owns and will own all such merchandise and other Inventory, and all cash receipts from the sale of Inventory (including credit cards sales) at any time after the Petition Date, all cash deposited at any such time in any Store Account or the Concentration Account, and all proceeds thereof (other than Excluded Proceeds), free and clear of all co-ownership interests, security interests, liens, entitlements, restrictions and encumbrances of any Person, including specifically each Pre-Petition Secured Creditor, except (x) Letter of Credit Liens granted to the Issuing Bank and enforceable by CITBC and (y) Letter of Credit Liens on up to $1,500,000 in purchase price of goods that were in shipment to the Borrower, but had not yet been received by it, on the Petition Date, which Letter of Credit Liens are released and discharged on the date of this Financing Agreement pursuant to the Wells Fargo Stipulation and Order. 6.2 INVENTORY RECORDS AND INSPECTION. The Borrower agrees to maintain accurate books and records pertaining to the Inventory and its proceeds, and such books and records shall be maintained in such a way that information sufficient to determine Eligible Inventory is at all times available. CITBC or its agents may from time to time (if no Default or Event of Default is then Continuing, upon reasonable notice) enter upon the Borrower's premises at any time during normal business hours, or at such other times as CITBC and the Borrower may agree, for the purpose of inspecting the Inventory and any and all records pertaining thereto, all at the Borrower's expense (except for CITBC's internal cost of inspecting or auditing Inventory incurred at any time when no Default or Event of Default is Continuing). 6.3 INVENTORY INSURANCE. The Borrower agrees to maintain insurance under policies of insurance, with insurance companies, in amounts and covering insurable risks on Inventory, as may be reasonably acceptable to CITBC, on 29 31 EXECUTION COPY terms no less favorable to the Borrower than the insurance coverage in place as of the date hereof, except that coverage limits may be reduced as and when warranted by Inventory reductions resulting from store closings. All policies covering the Inventory are to be made payable solely to CITBC (and any liquidator to the extent required in connection with the Store Closing Program) under a standard non-contributory clause and are to contain such other provisions as CITBC may reasonably require to fully protect by insurance CITBC's expectation of repayment from the proceeds of Inventory and grant CITBC the right to receive any payments to be made under such policies with respect to the Inventory. All original policies or true copies thereof are to be delivered to CITBC, with all premiums current and with a loss payable endorsement in CITBC's favor, and shall provide for not less than 30 days' prior written notice to CITBC of the exercise of any right of cancellation. If the Borrower fails to maintain such insurance, CITBC may arrange for such insurance, but at the Borrower's expense and without any responsibility on CITBC's part for obtaining the insurance, the solvency of the insurance companies, the adequacy of the coverage, or the collection of claims. Whenever any Default or Event of Default is Continuing, CITBC shall have the sole right, in the name of CITBC or the Borrower, to file claims under any insurance policies with respect to the Inventory, to receive, receipt and give acquittance for any payments that may be payable thereunder with respect to the Inventory, and to execute any and all endorsements, receipts, releases, assignments, reassignments or other documents that may be necessary to effect the collection, compromise or settlement of any claims with respect to the Inventory under any such insurance policies. In the event of any loss or damage by fire or other casualty, any and all insurance proceeds received by the Borrower relating to the Inventory shall be deposited, in the form received, in the Concentration Account. 6.4 TAXES. The Borrower will remit any and all sales taxes to the appropriate sales tax authorities when remittance is due and the Borrower and each Guarantor will pay, when due, all local, domestic and foreign (as applicable) taxes, assessments, claims and other charges (each, including sales taxes, a "tax") lawfully payable by or levied or assessed upon the Borrower or the Inventory or any sale of Inventory or any other income, receipts, proceeds or transaction, unless either (i) such tax is being diligently contested by the Borrower in good faith and by appropriate proceedings, the Borrower establishes such reserves as may be required by GAAP, and such tax is not secured by any claim, lien or trust enforceable against any Inventory or any proceeds thereof or against CITBC or (ii) in the case of any such tax that was due prior to the Petition Date, non-payment of such tax cannot reasonably be expected to result in the loss of any license, franchise or operating right necessary to the conduct of business or a successful reorganization herein or any claim, lien or trust enforceable against any Inventory or any proceeds thereof or against CITBC. CITBC shall have the right (but shall not be obligated) at any time on the Borrower's behalf to pay any tax then due as CITBC may in good faith deem necessary or 30 32 EXECUTION COPY appropriate to prevent the imposition or foreclosure of any tax claim, lien or trust against any Inventory or any proceeds thereof or against CITBC. 6.5 COMPLIANCE WITH LAWS AND ORDERS; INDEMNIFICATION. The Borrower and each Guarantor agrees to comply with all acts, rules, regulations and orders of any legislative, administrative or judicial body or official, including, but not limited to, the Fair Labor Standards Act, as set forth in Section 201 through Section 219 of Title 29 of the United States Code, and agrees to comply with all environmental statutes, acts, rules, regulations or orders as presently existing or as adopted or amended in the future, applicable to the ownership or use of its Real Estate or the operation of its business, except where (i) any such failure to comply resulted from good faith error or innocent omission, (ii) the Borrower or Guarantor promptly commences and diligently pursues a cure of such breach and such cure is eventually, within a reasonable time frame based upon the circumstances and the amount of work required, completed, and (iii) such failure has not resulted in a material adverse effect on the business, financial condition or operations of the Borrower and the Guarantors, taken as a whole. The Borrower and Guarantors hereby jointly and severally agree to indemnify CITBC and agree to defend and hold CITBC harmless from and against any and all loss, damage, claim, liability, injury or expense which CITBC may sustain or incur as a result of any such failure to comply by the Borrower or any Guarantor or in connection with any claim or expense asserted against CITBC as a result of any environmental pollution, hazardous material or environmental clean-up of any Real Estate, or any claim or expense which results from the Borrower's or any Guarantor's operations (including, but not limited to, off-site disposal practices). The Borrower and Guarantors agree that this indemnification shall survive for two years after the date of termination of this Financing Agreement and the payment of all Obligations payable hereunder. 6.6 REPORTING REQUIREMENTS. The Borrower agrees that, unless CITBC shall have otherwise consented in writing, the Borrower will furnish, or cause to be furnished, to CITBC, not later than (i) 90 days after the end of each fiscal year of the Borrower, an audited Balance Sheet as at the close of such year and statements of operations, cash flows, shareholders' equity and reconciliation of surplus for such year for The Clothestime, Inc. and its Subsidiaries, on a consolidated basis in accordance with GAAP and such changes in GAAP as may be required under GAAP and disclosed to CITBC, audited by independent public accountants selected by the Borrower and satisfactory to CITBC, accompanied by the unqualified opinion of such accountants (except for any qualification relating to the Cases); (ii) 30 days after the end of each fiscal month, except the fiscal month that ends a fiscal quarter, and 45 days after the end of each fiscal month that ends a fiscal quarter, an unaudited balance sheet as at the end of such fiscal month and unaudited statements of operations and cash flows of the Borrower and for The Clothestime, Inc. and its Subsidiaries on a 31 33 EXECUTION COPY consolidated basis for such fiscal month, certified by an authorized financial or accounting officer of the Borrower; (iii) on or before the third Business Day of each week, a flash report of sales for the immediately preceding week; and (iv) within a reasonable time, such further information regarding the Inventory, assets, liabilities, business affairs and financial condition of the Borrower as CITBC may reasonably request, including, without limitation, annual cash flow projections in form reasonably satisfactory to CITBC. Each financial statement required to be submitted under clauses (i) and (ii) above must be accompanied by an Officer's Certificate, signed by the President, Vice President - Chief Financial Officer, Controller, Treasurer or Assistant Treasurer of the Borrower, pursuant to which such officer must certify that (a) the financial statement(s) fairly and accurately represent(s) the financial condition of The Clothestime, Inc. and its Subsidiaries on a consolidated basis or the Borrower, as the case may be, at the end of the particular accounting period, as well as the operating results of The Clothestime, Inc. and its Subsidiaries on a consolidated basis or the Borrower, as the case may be, during such accounting period, in accordance with GAAP (subject, in the case of monthly statements, to normal year-end audit adjustments and the absence of notes) and such changes in GAAP as may be required under GAAP and disclosed to CITBC; (b) during the particular accounting period (1) no Default or Event of Default occurred or was Continuing or, if any such officer has knowledge of any such Default or Event of Default, disclosing the existence and setting forth a detailed description thereof; (c) a senior officer of the Borrower has not received any notice of cancellation with respect to its property insurance policies or certifying as to replacement policies therefor; and (d) the exhibits attached to such monthly and annual financial statement(s) constitute detailed calculations showing compliance with all financial covenants applicable for such period, if any, contained in this Financing Agreement. 6.7 MINIMUM EBITDA. The Borrower and the Guarantors shall not permit EBITDA for any of the fiscal quarters ending on the dates stated below to be less than the amount set forth next to such fiscal quarter below:
Fiscal Quarter EBITDA -------------- ------ April 27, 1996 (5,500,000) July 27, 1996 250,000 October 26, 1996 (1,000,000) January 25, 1997 (4,000,000) April 26, 1997 (4,000,000) July 26, 1997 1,000,000 October 25, 1997 (1,000,000)
32 34 EXECUTION COPY If any change in the computation or determination of EBITDA occurs by reason of any change in GAAP, compliance with the foregoing covenant shall continue to be computed and determined in accordance with GAAP as applied in the audited financial statements of The Clothestime, Inc. as at January 28, 1995 and for the twelve months then ended, unless and until the Borrowers and the Guarantors agree to any amendment hereto that may be proposed by CITBC in good faith to reflect such change in GAAP and to require that the Borrower and the Guarantors achieve substantially the same financial performance as that originally required hereunder. 6.8 NEGATIVE COVENANTS. Each of the Borrower and the Guarantors agrees that, without the prior written consent of CITBC, the Borrowers and Guarantors will not: A. NO OTHER SUPER-PRIORITY CLAIMS; NO LIENS. Incur, create, assume or permit or suffer to exist: 1. Any claim against or liability of the Borrower or any Guarantor or the estate in any of the Cases that has Super-Priority Status in any of the Cases, except (a) the Obligations and (b) the Second Tier Superpriority Claims required to be granted to Wells Fargo under the Wells Fargo Stipulation and Order, or 2. Any lien, charge, security interest or encumbrance (a) on any property of the estate in any of the Cases (excluding Inventory and proceeds of Inventory), except liens that had attached and were enforceable prior to the Petition Date or (b) on any Inventory or proceeds of Inventory, whether now owned or hereafter acquired, except for (x) Letter of Credit Liens granted to an Issuing Bank and enforceable by CITBC, (y) the interests in favor of CITBC created under this Financing Agreement and the Blocked Account Agreement, and (z) segregated bank deposits of Excluded Proceeds required to be made under the Wells Fargo Stipulation and Order; B. NO OTHER DEBT OR POST-PETITION LIABILITIES. Incur or otherwise become or remain liable for any Indebtedness, account payable or other liability incurred, assumed or arising at any time after the Petition Date, except (i) the Obligations, (ii) Case Costs, (iii) U.S. Trustee Fees, (iv) payroll costs and other employee expenses, (v) obligations under pre-petition leases of real or personal property or pre-petition executory contracts, whether or not assumed in any Case, (vi) liabilities arising under the Wells Fargo Stipulation and Order, and (vii) accounts payable and other similar liabilities for goods or services incurred and paid in the ordinary course of business and on customary terms. 33 35 EXECUTION COPY C. NO SALES OF ASSETS. Sell, lease, assign, transfer or otherwise dispose of (i) any Inventory, except Inventory sold by the Borrower in the ordinary course of its business or in a going-out-of-business sale for a particular retail store closed under the Store Closing Program or (if CITBC has received assurances satisfactory to it that, after giving effect to such disposition, the Availability will be greater than -0-) sold in bulk, or (ii) any other property or assets, except as contemplated in the Wells Fargo Stipulation and Order and except the sale of excess, obsolete or worn-out equipment or fixtures in the ordinary course of business or pursuant to the Store Closing Program; D. NO CHANGES IN STRUCTURE OR IN CONDUCT OF BUSINESS. Merge, consolidate or otherwise alter or modify its corporate structure or existence, or enter into or, except for store closings pursuant to the Store Closing Program, engage in any business, operation or activity materially different from that conducted by it immediately prior to the Petition Date; or permit the Borrower's sales, for any period, to constitute less than 95% of the total sales for such period reflected on the consolidated income statement of The Clothestime, Inc.; E. NO OTHER GUARANTIES. Assume, guarantee, endorse, or otherwise become liable upon the obligations of any Person, except (i) the Guaranty, (ii) the endorsement of negotiable instruments for deposit or collection or similar transactions in the ordinary course of business, and (iii) liabilities arising under the Wells Fargo Stipulation and Order; F. NO DIVIDENDS OR DISTRIBUTIONS. Declare or pay any dividend of any kind on, or purchase, acquire, redeem or retire, any of its capital stock or equity interest of any class whatsoever, whether now or hereafter outstanding; G. NO LOANS, ADVANCES OR INVESTMENTS. Make or hold any advance or loan to, or any investment in, any Person, except for (i) advances, loans or investments in existence on the date of execution of this Financing Agreement, (ii) Permitted Investments, but only if no Revolving Loans are outstanding, (iii) the segregated bank deposits required under the Wells Fargo Stipulation and Order, (iv) any Permitted Investment of the segregated cash proceeds of any property other than Inventory and proceeds of Inventory, (v) advances made by the Borrower to a Guarantor, so long as the aggregate outstanding amount of all such advances to any and all of the Guarantors made at any time after the Petition Date does not exceed $250,000, (vi) loans and advances to employees in the ordinary course of business for travel and entertainment, and (vii) advances made in the ordinary course of business for advertising and marketing costs; 34 36 EXECUTION COPY H. STORE CLOSINGS. Close any store or reject any store lease if, after giving effect to such closing or rejection, the Borrower would have fewer than 275 operating retail stores; I. RETURNS FOR CASH ONLY. Return any Inventory to any supplier unless the Borrower receives a full refund of the purchase price in cash, except for returns that are authorized pursuant to Section 546(g)* of the Bankruptcy Code and that, when counted (at the purchase price of the goods) as a Pre-Petition Claim Payment and added to all other Pre-Petition Claim Payments, would not cause the Pre- Petition Claim Payment Basket to be exceeded; J. NO PRE-PETITION CLAIM PAYMENTS. Make any Pre-Petition Claim Payment which, when added to all other Pre-Petition Claim Payments at any time made, would cause the Pre-Petition Claim Payment Basket to be exceeded; or K. TRANSACTIONS WITH AFFILIATES. Enter into any transaction (including, without limitation, any purchase, sale, lease, loan or exchange of property) with any Affiliate, other than (i) transactions in the ordinary course of business and on terms no less favorable than the terms otherwise attainable from a Person not an Affiliate, (ii) as otherwise permitted in this Financing Agreement, and (iii) customary compensation arrangements, including participation in employee benefit plans and performance of obligations under the Management Services Agreement dated as of January 30, 1994, between the Borrower and MRJ Industries, Inc., in accordance with the prior course of performance thereunder; or L. TRANSACTIONS WITH PRE-PETITION SECURED CREDITORS. Waive, amend, modify, release or otherwise change the provisions of the Wells Fargo Stipulation and Order or enter into an agreement, stipulation, agreed order or transaction with any Pre-Petition Secured Creditor in any respect which is inconsistent with this Financing Agreement or the Approval Orders, except upon CITBC's prior written consent. 6.9 MAXIMUM CAPITAL EXPENDITURES. The Borrower and the Guarantors will not make any Capital Expenditures or incur any liability under any Capital Lease in excess, in the aggregate for all of them, of (i) $750,000 in any one fiscal quarter, commencing with the fiscal quarter ending April 27, 1996, or (ii) $2,000,000 in any fiscal year. 6.10 ENVIRONMENTAL MATTERS. The Borrower and the Guarantors will promptly advise CITBC in writing of (i) all quantifiable expenditures (actual or anticipated) in excess of $500,000 pertaining to the Real Estate and operations in any fiscal year for environmental clean-up, environmental compliance or environmental 35 37 EXECUTION COPY testing and the impact of said expenses on the Borrower's cash forecast, and (ii) any notices received from any local, state or federal authority advising of any environmental liability (real or potential) that could reasonably be expected to exceed $500,000, stemming from any operations, premises, waste disposal practices, or waste disposal sites used by the Borrower or any Guarantor, with copies of all such notices if requested by CITBC. 6.11 ORGANIZATION, POWER AND AUTHORITY. Each of the Borrower and the Guarantors represents and warrants to CITBC that it (i) is a duly organized and validly existing Delaware corporation, (ii) is qualified to transact business in all states where the failure to so qualify would have a material adverse effect on its business or property or the ability of the Borrower to enforce collection of amounts owed for credit card sales, and (iii) has full power and authority to execute, deliver, obtain and repay extensions of credit and perform its obligations under this Financing Agreement and, in the case of a Guarantor, the Guaranty. SECTION 7. INTEREST, FEES AND EXPENSES 7.1 INTEREST. Interest on the Revolving Loans and all other amounts charged to the Borrower's loan account shall be payable monthly as of the end of each calendar month and shall accrue and become payable by the Borrower at a rate equal to (i) the sum of one-half percent (0.50%) per annum plus the Chemical Bank Rate, applied on a per annum basis on the average of the net balances (other than Libor Loans) owing by the Borrower to CITBC as reflected in the Borrower's loan account at the close of each day during such month or, at the Borrower's option, (ii) the sum of two and one-half percent (2-1/2%) per annum and the applicable Libor on any then outstanding Revolving Loans which are Libor Loans, applied on a per annum basis on the average of the net balances of Libor Loans outstanding at the close of each day during such month. The Borrower may elect to use Libor as to any new or then outstanding Revolving Loans if (w) no Default or Event of Default is then Continuing, (x) the Borrower has advised CITBC of its election to use Libor and the Libor Period selected no later than three Business Days prior to the proposed borrowing or, in the case of a Libor election with respect to a then outstanding Revolving Loan, prior to the first day of a Libor Period, (y) the Borrower pays a Libor election fee of $500 on the effective date of such election and (z) the election and Libor shall be effective, if no Default or Event of Default is then Continuing, on the fourth Business Day following said notice. The Libor elections must be for $500,000 or whole multiples thereof. If no such election is timely made or can be made, then CITBC shall use the Chemical Bank Rate to compute interest. In the event of any change in the Chemical Bank Rate, the rate hereunder shall change, as of the first of the month following any change, so as to remain one-half percent (0.50%) above the then Chemical Bank Rate. 36 38 EXECUTION COPY The rates hereunder shall be calculated based on actual days elapsed in a 360-day year. 7.2 LETTER OF CREDIT GUARANTY FEE. In consideration of the Letter of Credit Guaranty, the Borrower shall pay CITBC a Letter of Credit Guaranty Fee accrued and earned in advance at each issuance, extension or increase in any Letter of Credit, in an amount equal to one percent (1%) of the maximum amount available under such Letter of Credit applied on a per annum basis (using actual days elapsed in a 360-day year) from the date of issuance to its stated expiry date, with all fees so accrued and earned in any calendar month payable on the last Business Day of such month. 7.3 LETTER OF CREDIT COSTS. The Borrower shall reimburse CITBC for all charges, fees, commissions, costs and expenses charged to CITBC by any Issuing Bank in connection with or arising out of Letters of Credit issued pursuant to this Financing Agreement or covered by the Letter of Credit Guaranty. 7.4 OUT-OF-POCKET EXPENSES; DOCUMENTATION FEES. The Borrower shall reimburse or pay CITBC, as the case may be, for all Out-of-Pocket Expenses and all applicable Documentation Fees. 7.5 LINE OF CREDIT FEE. On the last Business Day of each calendar month, commencing December 29, 1995, the Borrower shall pay CITBC the Line of Credit Fee for such month. 7.6 LOAN FACILITY FEE. To induce CITBC to enter into this Financing Agreement and to make Revolving Loans hereunder, the Borrower shall pay to CITBC, on the date the Interim Approval Order is entered, a Loan Facility Fee in the amount of $250,000.00 (of which $100,000 shall be paid by crediting the Commitment Fee as set forth in paragraph 15 of the Commitment Letter). 7.7 INVENTORY MANAGEMENT FEE. The Borrower shall pay the Inventory Management Fee to CITBC (i) on the date the Interim Approval Order is entered and (ii) on each date that occurs six months thereafter or six months after any such prior six-month anniversary date, until Discharge of the Financing. 7.8 BREAKAGE COSTS. The Borrower shall pay to CITBC such amount or amounts as shall compensate CITBC and each of its transferees and participants, if any, for all losses, costs or expenses incurred by CITBC or any of its transferees or participants (as reasonably determined by CITBC or such transferee or participant) as a result of (i) any payment or prepayment of a Libor Loan on a day other than the last day of the Libor Period for such Libor Loan, or (ii) any failure of the Borrower to 37 39 EXECUTION COPY borrow a Libor Loan on the date for such borrowing specified in the relevant notice. Such compensation shall include, without limitation, an amount equal to any loss or expense suffered by CITBC or its transferee or participant, as the case may be, during the period from the date of receipt of such payment or prepayment or the date of such failure to borrow to the last day of such Libor Period if the rate of interest obtained by CITBC or its transferee or participants, as the case may be, upon the reemployment of an amount of funds equal to the amount of such payment, prepayment or failure to borrow is less than the rate of interest applicable to such Libor Loan for such Libor Period. The determination by CITBC or its tranferee or participant, as the case may be, of the amount of any such loss or expense, when set forth in a written notice to the Borrower, containing the calculations thereof in reasonable detail, shall be conclusive, in the absence of manifest error. 7.9 CHARGES TO THE LOAN ACCOUNT. The Borrower hereby requests and authorizes CITBC to charge the Borrower's loan account with the amount of all interest, fees, Out-of-Pocket Expenses and other Obligations specified in this Section 7 as payment thereof becomes due. CITBC is willing and intends to charge the loan account for such amounts but reserves the right not to do so at any time for any reason. In such event, CITBC may so notify the Borrower in writing and demand separate payment of such amount, and the amount so requested shall thereupon be due and payable three Business Days after such demand. 7.10 FEES EARNED AND NON-REFUNDABLE. All fees payable to CITBC shall be fully earned when due and non-refundable thereafter, regardless of any subsequent occurrence or contingency and even if any Letter of Credit is discharged or this Financing Agreement is terminated during any period for which advance payment was made. SECTION 8. POWER OF ATTORNEY Each of the Borrower and the Guarantors hereby constitutes CITBC and any employee, agent or nominee of CITBC, with full power of substitution, as the agent and attorney-in-fact of the Borrower and each Guarantor with the right and authority (but without any obligation whatsoever) at any time at the Borrower's cost and expense to exercise any or all of the following powers (which, being coupled with an interest, shall be irrevocable until Discharge of the Financing): to receive, take, endorse, sign, assign and deliver, all in the name of CITBC or the Borrower or any Guarantor, or any one of them, any and all checks, notes, drafts, and other documents or instruments relating to the Inventory for deposit to the Concentration Account or, at CITBC's option, whenever any Default or Event of Default is Continuing, for deposit to a collection account of CITBC. 38 40 EXECUTION COPY SECTION 9. EVENTS OF DEFAULT AND REMEDIES 9.1 EVENTS OF DEFAULT. Each of the following occurrences shall constitute an Event of Default hereunder: a. CHANGE AS TO APPROVAL ORDERS. The Interim Approval Order or the Final Approval Order is (or both are) vacated, annulled, reversed or (except upon CITBC's prior written consent) modified, amended or supplemented in any respect; or the Borrower or any Guarantor seeks, agrees to or joins in a request for entry of an order to vacate, annul, reverse or stay either or both of the Approval Orders or (except upon CITBC's prior written consent) to modify, amend or supplement either or both of the Approval Orders; or any other entity (except CITBC or any Affiliate of CITBC) seeks any such order and either (x) such request is not actively opposed by the Borrower and the Guarantors or (y) such request is not denied in its entirety by the Bankruptcy Court within 30 days after it was filed; or b. IMPAIRMENT OF CITBC'S RIGHTS AND REMEDIES. Except as provided in the Wells Fargo Stipulation and Order, (i) an order is entered invalidating or in any manner limiting, restricting, staying or restraining the remittance of any cash receipts from the sale of Inventory (including credit card sales) to the Concentration Account or to CITBC or the application of such funds to the payment of any of the Obligations or the collection of payment of any of the Obligations by CITBC or the exercise or enforcement of any of the rights and remedies of CITBC under this Financing Agreement, the Guaranty or the Blocked Account Agreement, or (ii) the Borrower or any Guarantor seeks, agrees to or joins in a request for any such order, or (iii) any other entity seeks any such order and either (x) such request is not actively opposed by the Borrower and the Guarantors or (y) such request is not denied in its entirety by the Bankruptcy Court within 30 days after it was filed; or c. TITLE TO INVENTORY AND ITS PROCEEDS. Any co-ownership interest, security interest, lien (except a Letter of Credit Lien granted to the Issuing Bank and enforceable by CITBC), charge, encumbrance, sale or transfer restriction or interest whatsoever exists, is outstanding or is approved by order of the Bankruptcy Court as to, upon or against any of the Borrower's Inventory, whether now existing or hereafter acquired or arising, or upon or against any proceeds thereof (other than Excluded Proceeds) generated or arising at any time after the Petition Date (whether or not such lien was granted prior to or after the commencement of the Cases and whether or not any such lien is perfected, avoidable or approved by the Bankruptcy Court); or the Borrower or any Guarantor purports to grant, or seeks, agrees to or joins in a request for, an order confirming or approving, any such lien; or any other entity seeks any such order and either (x) such request is not actively opposed by the 39 41 EXECUTION COPY Borrower and the Guarantors or (y) such request is not denied in its entirety by the Bankruptcy Court within 30 days after it was filed; or d. AUTHORIZATION OR INCURRENCE OF OTHER DEBT. An order is entered authorizing the Borrower or any Guarantor to obtain any credit or incur any debt, or the Borrower or any Guarantor obtains any credit or incurs any debt, except (i) unsecured credit for goods sold and delivered and services supplied in the ordinary course of business, subject and subordinate to the Obligations and CITBC's Super-Priority Status, (ii) a credit facility that is authorized and permitted to be funded only upon Discharge of the Financing, (iii) intercompany advances permitted under Section 6.8G, and (iv) liabilities arising under the Wells Fargo Stipulation and Order; or the Borrower or any Guarantor seeks, agrees to or joins in a request for any such order; or e. OTHER CLAIMS OR LIABILITIES GRANTED SUPER-PRIORITY STATUS. An order is entered (i) granting Super-Priority Status in any of the Cases to any claim, Person or entity, except in respect of the Obligations and except for any Second Tier Superpriority Claim granted to Wells Fargo, subject and subordinate to the Super-Priority Status of the Obligations, pursuant to the Wells Fargo Stipulation and Order, or (ii) otherwise impairing CITBC's right and prospect for payment of the Obligations in priority over all administrative expenses of the type specified in Section 503(b) or 507(B) of the Bankruptcy Code and over all claims and other liabilities of the estates in the Cases, both in the Cases as Chapter 11 cases and in any Chapter 7 case to which any of the Cases may be converted or any other successor or related proceeding, subject only to the Case Cost Carve-Out; or the Borrower or any Guarantor purports to grant, or seeks, agrees to or joins in a request for an order confirming or approving, Super-Priority Status to any administrative expense, claim or other liability in any of the Cases, other than (a) the Obligations, (b) any Second Tier Superpriority Claim required to be granted to Wells Fargo, subject and subordinate to the Super-Priority Status of the Obligations, pursuant to the Wells Fargo Stipulation and Order, and (c) any replacement credit facility that is authorized and permitted to be funded only upon Discharge of the Financing; or any other entity seeks any such order and either (x) such request is not actively opposed by the Borrower and the Guarantors or (y) such request is not denied in its entirety by the Bankruptcy Court within 30 days after it was filed; or f. ENFORCEMENT ACTIONS BY OTHER CREDITORS. An order is entered in any of the Cases modifying, limiting or terminating the automatic stay in any of the Cases, or granting other relief, so as to permit (i) any creditor having a lien on any property of the Borrower or any Guarantor (except property having a value not in excess of $250,000 and not necessary to a successful reorganization or the prudent and efficient conduct of business) to take possession of such property or to foreclose or 40 42 EXECUTION COPY otherwise enforce such lien, (ii) any creditor to collect or otherwise enforce any claim against the Borrower or any Guarantor or the property of the estates in the Cases, except (x) any claim for any payment expressly required to be paid under the Wells Fargo Stipulation and Order and (y) any claim which, if paid in full and counted as a Pre-Petition Claim Payment and added to all other Pre-Petition Claim Payments, would not cause the Pre-Petition Claim Payment Basket to be exceeded; or (iii) any lessor of any of the Borrower's retail stores to terminate any lease that has not been rejected by the Borrower; or g. PRE-PETITION CLAIM AND INTEREST PAYMENTS. The Borrower or any Guarantor makes, or an order of the Bankruptcy Court is entered authorizing the Borrower or any Guarantor to make, (i) any Pre-Petition Claim Payment which, when added to all other Pre-Petition Claim Payments at any time made, would cause the Pre-Petition Claim Payment Basket to be exceeded, or (ii) any payment or distribution on account of any pre-petition interest in any debtor in any of the Cases; or h. FINAL APPROVAL ORDER NOT ENTERED. The Final Approval Order is not entered on or before January 31, 1996; or i. STAY PENDING APPEAL OF APPROVAL ORDER. Either or both of the Approval Orders are subject to an appeal, and a stay pending appeal is entered on terms which CITBC or its counsel in good faith believes may limit, restrict or otherwise impair the enforceability of any Obligations that are then outstanding or any of the rights, remedies and benefits intended to be accorded to CITBC under this Financing Agreement and the Approval Orders in respect of any such Obligations; or j. DISMISSAL; SUSPENSION; CONVERSION; SUBSTANTIVE CONSOLIDATION. An order is entered dismissing any of the Cases or suspending proceedings in any of the Cases pursuant to Section 305 of the Bankruptcy Code or converting any of the Cases to a case under another Chapter of the Bankruptcy Code or substantively consolidating the estate or any property or claims in any of the Cases with the assets, liabilities, estate, property or claims of any other Person; or the Borrower or any Guarantor requests, agrees to or joins in a request for any such order; or k. APPOINTMENT OF TRUSTEE OR EXAMINER. A trustee or an examiner with expanded powers is appointed in any of the Cases; or the Borrower or any Guarantor requests, agrees to or joins in a request for any such appointment; or l. OPERATING RESTRICTIONS. The Borrower's right, power and authority to operate its retail stores and to acquire, hold and sell its Inventory is in any manner qualified, limited or restricted, whether by court order, agreement or any 41 43 EXECUTION COPY other means, except (i) by reason of the Borrower's election to reject a lease, (ii) pursuant to the Store Closing Program, or (iii) in any respect which CITBC in good faith determines not to be materially adverse to the Borrower or to the Borrower's ability to conduct its business, repay the Obligations and reorganize successfully in its Case; or m. POST-PETITION DEFAULT AS TO LEASES. The Borrower or any Guarantor fails to perform any obligation required to be performed by it under Section 365(d)(3) of the Bankruptcy Code, except (i) obligations disputed in good faith, (ii) obligations permitted to be deferred or suspended in connection with the Store Closing Program, and (iii) obligations under a lease of a retail store, if the Borrower is not in default under or as to leases of more than 10 of the Borrower's retail stores at any one time; and such failure continues for a period of more than 10 Business Days after notice thereof is received by the Borrower; or n. PLAN. The Borrower or any Guarantor or any other party in interest files a plan in any of the Cases that does not provide that all of the Obligations shall be paid in full in cash on the effective date of such plan, in priority over all other payments to be made thereunder; or o. MATERIALLY ADVERSE DEVELOPMENTS. A non-monetary judgment or order with respect to a post-petition event (other than the order that is part of the Wells Fargo Stipulation and Order or an order entered in the litigation contemplated thereby) is rendered against the Borrower or any Guarantor or entered in any of the Cases which does or could reasonably be expected to (i) cause a material adverse change in the condition (financial or otherwise), business, operations, properties or prospects of the Borrower or any Guarantor, (ii) have a material adverse effect on the ability of the Borrower or any Guarantor to repay the Obligations or perform its obligations under this Financing Agreement or any Blocked Account Agreement, or (iii) have a material adverse effect on the claims, rights and remedies of CITBC; or p. FAILURE TO PAY OBLIGATIONS. Any payment of principal, interest, fees or other Obligations required to be made to CITBC under this Financing Agreement is not paid when due and remains unpaid for five Business Days thereafter; or q. BREACH OF REPRESENTATION OR WARRANTY. Any representation or warranty made by the Borrower or any Guarantor in this Financing Agreement is not in all material respects true, correct and complete on the date of this Financing Agreement or as of (i) any Reporting Date (whether or not any required report is delivered on such Reporting Date), (ii) any date on which a Revolving Loan is made or requested by the Borrower or a Letter of Credit is requested, issued, extended or 42 44 EXECUTION COPY amended or (iii) any date on which any Obligation is posted to the Borrower's loan account by CITBC; or any statement, representation or warranty made by the Borrower or any Guarantor in any other Loan Document or any information set forth in any financial statement, report or certificate delivered to CITBC pursuant to this Financing Agreement is not in all material respects true, correct and complete on the date on which such representation or warranty was made or such statement, report or certificate was delivered to CITBC; or r. BREACH OF CERTAIN AGREEMENTS. The Borrower or any Guarantors fails duly and punctually to perform and observe any of the agreements set forth in Sections 3.4, 3.7, 3.9, 5.1, 5.2, 5.3, 6.1, 6.2, 6.4, 6.7, 6.8 or 6.9; or s. FAILURE TO DELIVER INVENTORY REPORT The Borrower fails to perform any of the agreements set forth in Section 3.2, and such failure continues for three Business Days; or t. BREACH OF OTHER AGREEMENTS OR OBLIGATIONS. The Borrower or any Guarantor fails duly and punctually to perform or observe any other agreement or obligation under this Financing Agreement or any other Loan Document, and such failure continues for 10 Business Days after the Borrower acknowledges such failure or receives notice thereof; or u. ERISA MATTERS. The Borrower or any Guarantor (i) engages in any "prohibited transaction" as defined in ERISA, (ii) has any "accumulated funding deficiency" as defined in ERISA, (iii) has any Reportable Event as defined in ERISA, (iv) terminates any Plan, as defined in ERISA or (v) is engaged in any proceeding in which the Pension Benefit Guaranty Corporation shall seek appointment, or is appointed, as trustee or administrator of any Plan, as defined in ERISA, and such event or condition (x) remains uncured for 30 days from date of occurrence and (y) could reasonably be expected to subject the Borrower or such Guarantor to any tax, penalty or other liability in an amount exceeding $250,000; or v. NULLIFICATION, MODIFICATION OR REPUDIATION OF WELLS FARGO RELEASE. The provisions of subparagraph c of paragraph 1 of the stipulation, as approved pursuant to the order, in the Wells Fargo Stipulation and Order shall be in any respect repudiated by Wells Fargo or annulled, invalidated, modified, amended or otherwise changed. 9.2 SUSPENSION OF CITBC'S COMMITMENT. Upon the occurrence of any Default or Event of Default, at the option of CITBC, CITBC's obligation to make Revolving Loans and assist the Borrower in obtaining Letters of Credit shall (if not terminated by CITBC pursuant to Section 9.3) be suspended for so long as any 43 45 EXECUTION COPY Default or Event of Default is Continuing. Nevertheless, CITBC shall have the right (without the obligation) to continue making Revolving Loans and assisting the Borrower in obtaining Letters of Credit, at CITBC's sole discretion. 9.3 TERMINATION, ACCELERATION, DEFAULT INTEREST. Upon the occurrence of an Event of Default and at any time thereafter for so long as any Event of Default is Continuing, CITBC may give the notice described in Section 9.9 and shall thereupon have the immediate, absolute, unconditional and unqualified right, without necessity of any leave or authorization from the Bankruptcy Court, to take any or more or all of the following actions, in any order or sequence and at any time: a. TERMINATION. CITBC may immediately terminate its obligation to make Revolving Loans and to assist the Borrower in obtaining Letters of Credit and all other obligations of CITBC under this Financing Agreement; b. ACCELERATION. CITBC may immediately declare all outstanding Obligations to be due and payable, and the same thereupon shall be immediately and payable, without further notice or demand; and c. DEFAULT RATE OF INTEREST. CITBC may charge the Default Rate of Interest on all then outstanding or thereafter incurred Obligations. 9.4 CONTROL OVER INVENTORY; COLLECTION OF PROCEEDS. Upon the occurrence of any Event of Default and at any time thereafter for so long as any Event of Default is Continuing, whether or not CITBC has exercised any of the rights and remedies set forth in Sections 9.2 and 9.3 and without necessity of any leave or authorization of the Bankruptcy Court, CITBC at any time and from time to time may (i) enter upon and remove from any premises where the same may be located copies of any and all documents, instruments, files and records relating to the Inventory, (ii) use such of the Borrower's personnel, supplies or space at the Borrower's retail stores, distribution center and other places of business or otherwise, as may be necessary to properly administer, control and sell the Inventory or the handling of collections and realizations thereon, (iii) collect all cash proceeds of Inventory (other than Excluded Proceeds), either on the sale premises or directly from the purchaser or through any special account or remittance arrangement, (iv) collect all non-cash proceeds of Inventory, including proceeds from credit card sales and other obligations representing proceeds of Inventory (but excluding Excluded Proceeds), and in connection therewith CITBC may bring suit, in the name of the Borrower or CITBC, to enforce collection thereof, (v) generally exercise and enforce all other rights and remedies of the Borrower respecting the sale of Inventory and the collection and enforcement of the proceeds thereof (other than Excluded Proceeds), all as CITBC from time to time may elect, including, without limitation, the right to accelerate or 44 46 EXECUTION COPY extend the time of payment, settle, compromise, release in whole or in part any amounts owing and issue credits in the name of the Borrower or CITBC, and (vi) exercise any or all other rights and remedies provided in law, in equity, by contract or otherwise. 9.5 LIQUIDATION OF INVENTORY. If any of the Obligations are not paid when due on the Termination Date or are declared due and payable as set forth in Section 9.3, then CITBC shall have the immediate, absolute, unconditional and unqualified right, without necessity of any leave or permission from the Bankruptcy Court, to require that the Borrower immediately sell the Inventory, either in its then location in the ordinary course or in going out of business sales, or immediately assemble, transport and sell the Inventory in bulk in one or more lots or sales or otherwise at any commercially reasonable time or in any commercially reasonable manner requested by CITBC, and the Borrower agrees to take all commercially reasonable actions requested by CITBC in connection therewith in order to liquidate the Inventory and pay the Obligations, at the earliest reasonable time in a commercially reasonable manner, and further agrees to deliver all proceeds of all such sales to CITBC, in the form received, for application to the payment of the Obligations. 9.6 RELIEF FROM THE AUTOMATIC STAY. To the extent that the automatic stay under Section 362 of the Bankruptcy Code would otherwise prohibit or restrain the exercise of any right or remedy of CITBC described in or granted or available to it under this Financing Agreement (including, without limitation, the rights and remedies set forth in this Section 9) or any Blocked Account Agreement or any other Loan Document, the Approval Orders shall grant CITBC relief from the automatic stay so as to permit CITBC freely to exercise and enforce any and all of such rights and remedies. Each of the Borrower and the Guarantors covenants and agrees that it will not, under any circumstances, seek reimposition of the automatic stay or seek any other injunctive relief that might restrict, delay or hinder the exercise or enforcement of any such right or remedy, or take any other action intended to restrict, delay or hinder the exercise or enforcement of any such right or remedy. 9.7 FURTHER ORDERS OF THE BANKRUPTCY COURT. The Borrower and the Guarantors hereby stipulate and consent to entry of any order of the Bankruptcy Court that may be requested by CITBC (i) directing the Borrower and the Guarantors to take any action requested by CITBC which the Borrower or any Guarantor is obligated to take, or which CITBC has the right to request, under Section 9.4 or Section 9.5, (ii) confirming that any or all of CITBC's rights and remedies may be exercised free from restraint under the automatic stay, as set forth in Section 9.6, and free from any other restraint which might otherwise be effective under any order (other than the Wells Fargo Stipulation and Order) entered in any of the Cases, and (iii) restraining the 45 47 EXECUTION COPY Borrower and the Guarantors from taking any action which they covenant and agree not to take under Section 9.6. 9.8 CASE COST CARVE-OUT. Notwithstanding the Super-Priority Status of the Obligations, upon written request of the Borrower or the Official Committee delivered to CITBC at any time after CITBC terminates its obligation to extend credit hereunder as set forth in Section 9.3, CITBC will release cash proceeds of Inventory that become payable to CITBC after such request is received by CITBC, up to an amount that shall not, in the aggregate, exceed the difference between (i) $500,000 and (ii) all Case Costs (whenever incurred or arising) paid from any other source at any time after such termination of CITBC's obligation to extend credit; PROVIDED, HOWEVER, that such proceeds shall only be released for the purpose of paying Case Costs that were not incurred, directly or indirectly, to contest the enforceability or enforcement of any of the Obligations or the exercise or enforcement of any of CITBC's rights or remedies or in connection with any other claim, motion, adversary proceeding or other litigation adverse to CITBC. CITBC shall have the right, at its sole option, to discharge its obligation under this Section 9.8 at any time, by depositing $500,000 in proceeds of Inventory delivered to CITBC, less the sum of (i) all cash proceeds previously released by CITBC under this Section 9.8 and (ii) all Case Costs paid from any other source at any time after such termination of CITBC's obligation to extend credit, to a separate account under CITBC's control for disbursement to pay Case Costs subject to the proviso above. 9.9 NOTICE OF EXERCISE OF RIGHTS UNDER SECTION 9.3. At least three Business Days prior to exercising any of its rights under Section 9.3, CITBC shall serve upon the Borrower, the Official Committee and Wells Fargo written notification to the effect that CITBC intends to exercise one or more of its rights under Section 9.3. No other notice shall be required as a condition to or in connection with the exercise or enforcement of any of CITBC's rights or remedies under any of the Loan Documents. The notice required under this Section 9.9 need only be given once, need not be given to any other Person, need only state that CITBC intends to exercise one or more of its rights under Section 9.3, need not set forth any additional information whatsoever (whether relating to the occurrence or continuance of any Event of Default or the time, manner or order in which any of CITBC's rights or remedies may be exercised or any delay or change therein or otherwise), and shall be sufficiently given if served, in any manner permitted by law for service of a motion in the Cases, upon counsel of record in the Cases for the Borrower, the Official Committee and Wells Fargo. 9.10 BREACH NOT EXCUSED. No breach of any of the agreements set forth in Sections 3.7, 6.1, 6.8A, 9.1c or any other provision of this Financing Agreement relating to the Borrower's title to any funds that are Special Payments shall 46 48 EXECUTION COPY be excused, shall be deemed not to be or not to give rise to a Default or an Event of Default, or shall be deemed waived by CITBC, by reason of (i) CITBC's establishment of any Special Payments Reserve, (ii) any election made by CITBC in establishing the amount of any Special Payments Reserve from day or day, or (iii) any lawful action, not constituting a breach of contract, taken or omitted by CITBC in connection therewith. SECTION 10. TERMINATION Unless terminated prior to such date as herein provided or unless extended in writing by CITBC in its sole and absolute discretion, CITBC's obligations under this Financing Agreement shall terminate on the Termination Date. The Borrower may, at any time, terminate CITBC's obligations under this Financing Agreement and the Line of Credit upon at least five days' prior written notice to CITBC. Such notice shall be irrevocable and all Obligations shall become due and payable as of any termination hereunder or under Section 9 hereof. After termination and until Discharge of the Financing, all of CITBC's rights and remedies shall continue, and CITBC may withhold any credit balances in the loan account (unless supplied with an indemnity satisfactory to CITBC) to cover all outstanding Letters of Credit and all other outstanding Obligations, whether absolute or contingent, except that if the remaining unpaid Obligations relate solely to contingent reimbursement obligations for amounts that are available to be drawn, but have not been drawn, under outstanding Letters of Credit or to Contingent Indemnification Obligations, CITBC will, if the Borrower so requests, retain, solely as cash collateral, credit balances in an amount equal to 105% of the maximum amount then or at any time thereafter available for drawing under all Letters of Credit then outstanding. When all outstanding Letters of Credit have been so secured by cash collateral deposited with CITBC in an amount equal to 105% of such maximum amount, pursuant to a duly executed agreement between CITBC and the Borrower and the Guarantors and pursuant to which the Borrower and the Guarantors jointly and severally agree to indemnify CITBC for any Letter of Credit claims and costs that exceed the cash collateral, then this Financing Agreement shall be terminated, except that such indemnity and all other indemnification obligations of the Borrower and the Guarantors hereunder shall survive such termination and shall survive Discharge of the Financing. 47 49 EXECUTION COPY SECTION 11. MISCELLANEOUS 11.1 WAIVERS. The Borrower and each Guarantor hereby waives diligence, demand, presentment and protest and any notices thereof as well as notice of nonpayment, notice of dishonor, notice of intent to accelerate, notice of acceleration and all other notices and demands that might otherwise be required to be given to the Borrower or any Guarantor, except those expressly required in this Financing Agreement or any Approval Order. No delay or omission by CITBC as to the exercise any right or remedy hereunder, whether before or after the occurrence of any Event of Default, shall impair any such right or shall operate as a waiver thereof or as a waiver of any Event of Default. No single or partial exercise by CITBC of any right or remedy precludes any other or further exercise thereof, or precludes any other right or remedy. 11.2 SIGNED WRITING REQUIRED; GUARANTORS BOUND. Neither this Financing Agreement nor any provision hereof may be waived, amended or modified except as expressly set forth in a written agreement signed by the Borrower and CITBC. Each Guarantor agrees to be bound by any such agreement signed by the Borrower and waives any right separately to be notified thereof or separately to consent thereto. 11.3 NO EXTRINSIC EVIDENCE. THIS WRITTEN AGREEMENT AND THE OTHER DOCUMENTS REFERENCED HEREIN OR CONTEMPLATED HEREBY REPRESENT THE FINAL AGREEMENT AMONG THE PARTIES AND MAY NOT BE CONTRADICTED BY EVIDENCE OF PRIOR, CONTEMPORANEOUS OR SUBSEQUENT ORAL AGREEMENTS OF THE PARTIES HERETO. THERE ARE NO UNWRITTEN ORAL AGREEMENTS AMONG THE PARTIES. 11.4 USURY LAWS. It is the intent of the Borrower, the Guarantors and CITBC to conform strictly to all applicable state and federal usury laws. All agreements between the Borrower and CITBC, whether now existing or hereafter arising and whether written or oral, are hereby expressly limited so that in no contingency or event whatsoever, whether by reason of acceleration of the maturity hereof or otherwise, shall the amount contracted for, charged or received by CITBC for the use, forbearance, or detention of the money loaned hereunder or otherwise, or for the payment or performance of any covenant or obligation contained herein or in any other Loan Document which may be legally deemed to be for the use, forbearance or detention of money, exceed the maximum amount which CITBC is legally entitled to contract for, charge or collect under applicable state or federal law. If from any circumstance whatsoever fulfillment of any provisions hereof or of such other Loan Document, at the time performance of such provision shall be due, shall involve 48 50 EXECUTION COPY transcending the limit of validity prescribed by law, then the obligations to be fulfilled shall be automatically reduced to the limit of such validity, and if from any such circumstance CITBC shall ever receive as interest or otherwise an amount in excess of the maximum that can be legally collected, then such amount which would be excessive interest shall be applied to the reduction of the principal indebtedness hereof and any other amounts due with respect to the Obligations evidenced hereby, but not to the payment of interest and if such amount which would be excessive interest exceeds the Obligations and all other non interest indebtedness described above, then such additional amount shall be refunded to the Borrower. In determining whether or not all sums paid or agreed to be paid by the Borrower for the use, forbearance or detention of the Obligations of the Borrower to CITBC, under any specific contingency, exceeds the maximum amount permitted by applicable law, the Borrower and CITBC shall to the maximum extent permitted under applicable law, (a) characterize any non-principal payment as an expense, fee or premium rather than as sums paid or agreed to be paid by the Borrower for the use, forbearance or detention of the Obligations of the Borrower to CITBC, (b) exclude voluntary prepayments and the effect thereof, and (c) to the extent not prohibited by applicable law, amortize, prorate, allocate and spread in equal parts, the total amount of all sums paid or agreed to be paid by the Borrower for the use, forbearance or detention of the Obligations of the Borrower to CITBC throughout the entire contemplated term of the Obligations so that the interest rate is uniform throughout the entire term of the Obligations. The terms and provisions of this paragraph shall control and supersede every other provision hereof and all other agreements between the Borrower and CITBC. 11.5 SEVERANCE. If any provision hereof or of any other agreement made in connection herewith is held to be illegal or unenforceable, such provision shall be fully severable, and the remaining provisions of the applicable agreement shall remain in full force and effect and shall not be affected by such provision's severance. Furthermore, in lieu of any such provision, there shall be added automatically as a part of the applicable agreement a legal and enforceable provision as similar in terms to the severed provision as may be possible. 11.6 SALE OF LOANS OR PARTICIPATIONS. CITBC shall have the right to transfer or sell the Obligations, or a participating interest therein, to any financial institution or commercial finance lender, solely in CITBC's discretion, but (i) CITBC shall not be relieved of its commitment hereunder by reason of any such transfer, even if such commitment is assumed by a transferee, (ii) CITBC shall not, prior to the Termination Date, delegate or transfer its right to establish reserves for purposes of determining the Eligible Inventory or any of CITBC's other discretionary rights related to the determination of the Borrowing Base or the Availability, (iii) no transferee or participant shall, by reason of any such transfer or sale, acquire the right to apply any bank deposit, proceeds of Inventory or other property to the payment any 49 51 EXECUTION COPY liability which is not an Obligation, and (iv) the Borrower shall not be responsible for any fees, charges or costs arising out of any such transfer or participation except as otherwise provided in Section 7.8. If CITBC transfers any Obligation or sells any participation therein, CITBC will endeavor (as a matter of courtesy only and without being in any manner obligated to do so or liable for any failure to do so) to advise the Borrower of the sale, the identity of the transferee or participant and, generally, of the rights of the transferee or participant to approve amendments, consents or waivers. 11.7 WAIVER OF JURY TRIAL; CONSENT TO JURISDICTION. TO THE FULLEST EXTENT PERMITTED BY LAW, EACH OF THE BORROWER, THE GUARANTORS AND CITBC HEREBY WAIVES ANY RIGHT TO A TRIAL BY JURY IN ANY ACTION OR PROCEEDING ARISING OUT OF THIS FINANCING AGREEMENT. THE BORROWER AND EACH GUARANTOR HEREBY IRREVOCABLY WAIVES PERSONAL SERVICE OF PROCESS AND CONSENTS TO SERVICE OF PROCESS BY CERTIFIED OR REGISTERED MAIL, RETURN RECEIPT REQUESTED. ANY JUDICIAL PROCEEDING BROUGHT BY OR AGAINST THE BORROWER OR ANY GUARANTOR WITH RESPECT TO ANY OF THE OBLIGATIONS, THIS FINANCING AGREEMENT OR ANY RELATED AGREEMENT MAY BE BROUGHT IN ANY COURT OF COMPETENT JURISDICTION IN THE STATE OF CALIFORNIA, UNITED STATES OF AMERICA, AND, BY EXECUTION AND DELIVERY OF THIS FINANCING AGREEMENT, THE BORROWER AND EACH GUARANTOR ACCEPTS FOR ITSELF AND IN CONNECTION WITH ITS PROPERTIES, GENERALLY AND UNCONDITIONALLY, THE NON-EXCLUSIVE JURISDICTION OF THE AFORESAID COURTS AND IRREVOCABLY AGREES TO BE BOUND BY ANY FINAL, NON-APPEALABLE JUDGMENT RENDERED THEREBY IN CONNECTION WITH THIS FINANCING AGREEMENT. THE BORROWER AND EACH GUARANTOR WAIVES ANY OBJECTION TO JURISDICTION AND VENUE OF ANY ACTION INSTITUTED HEREUNDER AND SHALL NOT ASSERT ANY DEFENSE BASED ON LACK OF JURISDICTION OF VENUE OR BASED UPON FORUM NON CONVENIENS. NOTHING HEREIN SHALL AFFECT THE RIGHT TO SERVE PROCESS IN ANY MANNER PERMITTED BY LAW OR SHALL LIMIT THE RIGHT OF CITBC TO BRING PROCEEDINGS AGAINST THE BORROWER OR ANY GUARANTOR IN THE COURTS OF ANY OTHER JURISDICTION. 11.8 NOTICES. Except as otherwise herein provided, any notice or other communication required hereunder shall be in writing, and shall be deemed to have been validly served, given or delivered when hand delivered, including overnight delivery by a courier service or sent by telegram or facsimile, or five days after deposit in the United States mails, with proper first class postage prepaid and addressed to the party to be notified as follows: 50 52 EXECUTION COPY A. If to CITBC, at: The CIT Group/Business Credit, Inc. 300 South Grand Avenue Los Angeles, CA 90071 Attn: Regional Manager Facsimile Number: (213) 613-2588 B. If to the Borrower or any Guarantor, at: Clothestime Stores, Inc. 5325 East Hunter Avenue Anaheim, California 92807 Attn: Chief Financial Officer Facsimile Number: (714) 779-8421 C. If to the Official Committee, at: Official Committee of Unsecured Creditors The Clothestime, Inc. c/o Siegel, Sommers & Schwartz LLP 470 Park Avenue South 16th floor New York, NY 10016 Att'n: Lawrence Gottlieb Facsimile Number: (212) 889-0688 or to such other address as any party may designate for itself by like notice. 11.9 GOVERNING LAW. The validity, interpretation and enforcement of this Financing Agreement shall be governed by the laws of the State of California, subject to all applicable provisions of the United States Bankruptcy Code. 11.10 WAIVER OF CLAIM FOR SPECIAL, INDIRECT, CONSEQUENTIAL AND PUNITIVE DAMAGES. Neither CITBC nor any of CITBC's affiliates, directors, officers, employees, attorneys or agents shall ever be liable under or in respect of this Financing Agreement or any other Loan Document or the financing transactions contemplated hereby or any act, omission, breach, tort, wrongful conduct, occurrence or event in any manner related hereto, on any theory of liability (whether contract, tort, duty imposed by law, or otherwise), for any special, indirect, consequential or punitive damages, and the Borrower and each Guarantor hereby waive, release and agree never to sue upon any claim for any such damages. 51 53 EXECUTION COPY 11.11 CITBC'S APPROVAL, SATISFACTION AND DISCRETION. Wherever, in this Financing Agreement, any act, document or matter is required to be approved by CITBC or to be satisfactory to CITBC or any action is permitted or authorized to be taken by CITBC in its discretion, CITBC may freely grant or withhold such approval, determine whether such act, document or matter is satisfactory, or take or decline or fail to take any such action, in each case at CITBC's sole option and election and without any obligation or limitation whatsoever, except that CITBC act in good faith. 11.12 INDEMNIFICATION. The Borrower and the Guarantors jointly and severally agree to defend, indemnify and hold harmless CITBC and its affiliates and their respective directors, officers, employees, attorneys, agents and representatives, and the heirs, representatives, successors and assigns of each of them, from and against all claims, liabilities, losses, damages, costs and expenses (including the reasonable fees and disbursements of their attorneys, whether or not suit is brought) asserted, incurred, imposed or arising in any manner as a result of or in connection with the execution, delivery or performance by CITBC of this Financing Agreement or any Blocked Account Agreement or the use of any proceeds of the credit extended hereunder or the exercise or enforcement of any right or remedy of CITBC or any action taken or omitted or event occurring in connection therewith, except only that such indemnification shall not be apply to any claim, liability, loss, damage, cost or expense that is finally determined by a court of competent jurisdiction to have resulted from the willful misconduct or gross negligence of the Person otherwise to be indemnified hereunder. 11.13 SUCCESSORS AND ASSIGNS. This Financing Agreement shall be binding upon and enforceable by CITBC, its successors and assigns, and the Borrower and each Guarantor, in each instance both individually and as debtor in possession, and the estate in each of the Cases and shall be binding upon and enforceable against any trustee appointed in any of the Cases and the estate and trustee in any Chapter 7 case to which any of the Cases may be converted and all other successor trustees, estates and proceedings. All administrative expenses and other liabilities incurred in any such Chapter 7 case or in any such other successor proceeding shall be in all respects subject and subordinate to the prior payment, in full and in cash, of all of the Obligations, and the Super-Priority Status of the Obligations shall continue unimpaired and unaffected in any such Chapter 7 case or other successor proceeding. The Borrower's right to obtain credit under this Financing Agreement is personal to the Borrower, as debtor in possession of the Chapter 11 estate in the Borrower's Case, and may not be assigned to any Person. 11.14 NO OTHER DUTY. The relationship between the Borrower and the Guarantors, on the one hand, and CITBC, on the other hand, is solely that of debtors and creditor. CITBC is not undertaking to act, and shall not be obligated, as agent or 52 54 EXECUTION COPY other fiduciary for the Borrower or any Guarantor, and CITBC shall not be subject to any duty of loyalty, duty of disclosure, duty of care or any other fiduciary duty or special duty to the Borrower or any of the Guarantors. CITBC's duty, liability and obligation under this Financing Agreement or in respect of, in connection with or as a result of any of the transactions or matters contemplated hereby shall be CITB's contractual obligation, as set forth herein, to extend credit to the Borrower on the terms and subject to the conditions set forth herein and obligations ancillary thereto that are either (i) expressly set forth in, and expressly assumed by CITBC under, any of the Loan Documents or (ii) imposed upon CITBC pursuant to mandatory requirements of applicable law not effectively waived by the Borrower and the Guarantors. To the fullest extent they may lawfully do so, each of the Borrower and the Guarantors hereby waives any and all such ancillary duties, liabilities and obligations that would otherwise be imposed on CITBC by law. 11.15 CONFIDENTIALITY. CITBC agrees that it will not, without the prior consent of the Borrower or a Guarantor, disclose any information with respect to the Borrower or any Guarantor which is furnished to CITBC pursuant to this Financing Agreement and which the Borrower or a Guarantor has notified CITBC, in writing, constitutes confidential information, except (i) to CITBC's directors, officers, employees, agents and financial and legal advisors under instructions to maintain confidentiality, (ii) to any actual or prospective transferee or participant under Section 11.06, so long as such transferee or participant agrees to be bound by the provisions of this Section 11.14, (iii) information that is known to CITBC or its directors, officers, employees or advisors prior to its disclosure by the Borrower or a Guarantor, (iv) information that has become publicly available other than by CITBC's improper disclosure, (v) information that is obtained from any source other than the Borrower and the Guarantors, unless CITBC has actual knowledge that such source disclosed such information to CITBC in breach of an obligation of confidentiality, and (vi) as may be required or appropriate in any proceeding to collect the Obligations or protect or enforce any right or remedy of CITBC under the Loan Documents or in defense of any claim asserted against CITBC or in any other litigation or for compliance with any applicable law or any subpoena, discovery request or other legal process, so long as CITBC (if not prohibited from doing so) gives the Borrower at least three Business Days' prior notice thereof. 11.16 CAPTIONS AND CATCHLINES. The captions and catchlines herein are intended for convenience of reference only and shall not be used to define, construe, interpret or limit any of the provisions hereof. 11.17 COUNTERPARTS. This Financing Agreement may be executed in counterparts, each of which shall constitute an original but all of which when taken together shall constitute but one agreement. 53 55 EXECUTION COPY IN WITNESS WHEREOF, the parties hereto have caused this Financing Agreement to be executed and delivered by their proper and duly authorized officers as of the date set forth above. THE CIT GROUP/BUSINESS CREDIT, INC. By /s/ Bonnie Schain --------------------------------------- Assistant Vice President CLOTHESTIME STORES, INC., as Debtor and Debtor in Possession By /s/ David A. Sejpal --------------------------------------- Title: Special Agent THE CLOTHESTIME, INC., as Debtor and Debtor in Possession By /s/ David A. Sejpal --------------------------------------- Title: Vice President, Chief Financial Officer, Treasurer and Secretary MRJ INDUSTRIES, INC., as Debtor and Debtor in Possession By /s/ David A. Sejpal --------------------------------------- Title: Vice President, Chief Financial Officer, Treasurer and Assistant Secretary CLOTHESTIME INVESTMENT, INC. as Debtor and Debtor in Possession By /s/ David A. Sejpal --------------------------------------- Title: President and Secretary 54 56 EXECUTION COPY CLOTHESTIME INTERNATIONAL, INC., as Debtor and Debtor in Possession By /s/ David A. Sejpal --------------------------------------- Title: Special Agent CLOTHESTIME ACQUISITION CORPORATION, as Debtor and Debtor in Possession By /s/ David A. Sejpal --------------------------------------- Title: Vice President, Chief Financial Officer, Treasurer and Assistant Secretary 55 57 EXECUTION COPY LIST OF EXHIBITS A - Blocked Account Agreement B - Guaranty C - Interim Approval Order D-1 - Wells Fargo Stipulation D-2 - Order on Wells Fargo Stipulation E - Opinion of Counsel to the Borrower and Guarantors F - Form of Inventory Confirmation Certificate 56 EX-10.56 6 GUARNTY 1 EXHIBIT 10.56 EXECUTION COPY GUARANTY This GUARANTY, dated as of December 28, 1995, is made by THE CLOTHESTIME, INC., MRJ INDUSTRIES, INC., CLOTHESTIME INVESTMENT, INC., CLOTHESTIME INTERNATIONAL, INC. and CLOTHESTIME ACQUISITION CORPORATION, as Debtors and Debtors in Possession (each, a "Guarantor"), in favor of THE CIT GROUP/BUSINESS CREDIT, INC., a New York corporation (the "Lender"), and all other present and future Holders of any of the Guaranteed Obligations described herein. RECITALS A. On December 8, 1995, Clothestime Stores, Inc., a Delaware corporation (the "Borrower"), and the Guarantors filed voluntary petitions for relief under Chapter 11 of the United States Bankruptcy Code with the United States Bankruptcy Court for the Central District of California. An order directing joint administration of the bankruptcy cases so commenced was entered therein on December 8, 1995. The Borrower and the Guarantors are operating their businesses and managing their affairs as debtors in possession pursuant to Sections 1107 and 1108 of the Bankruptcy Code. No trustee or examiner has been appointed in any of the Chapter 11 cases. B. The Borrower and the Guarantors have applied to the Lender for a $40,000,000 financing facility to be used by the Borrower for working capital and other purposes. C. The Lender is willing to provide such a financing facility on the terms and subject to the conditions set forth in a Financing Agreement dated as of December 28, 1995, by and among the Lender, the Borrower and the Guarantors (the "Financing Agreement"), including, but not limited to, the agreement of the Guarantors to undertake the obligations set forth in this Guaranty and the agreement of the Borrower and the Guarantors that all their present and future liability for payment of all Obligations and Guaranteed Obligations from time to time outstanding shall constitute an allowed administrative expense in each of the Chapter 11 bankruptcy cases that shall have, pursuant to Section 364(c)(1) of the Bankruptcy Code, priority over all administrative expenses of the kind specified in Sections 503(b) and 507(b) of the Bankruptcy Code. 2 EXECUTION COPY D. Each Guarantor is an affiliate of the Borrower and expects to derive substantial direct and indirect benefit from the transactions contemplated by the Financing Agreement. E. It is a condition precedent to the extension of credit under the Financing Agreement that each Guarantor shall have guaranteed payment of each and all the Guaranteed Obligations on the terms set forth herein. NOW, THEREFORE, in consideration of the foregoing and in order to induce the Lender to extend credit to the Borrower under the Financing Agreement, each Guarantor hereby agrees as follows: ARTICLE I DEFINITIONS AND ACCOUNTING TERMS SECTION 1.1 General Definitions. Except as otherwise specifically provided herein, the terms which are defined in Section 1 of the Financing Agreement shall have the same meanings when used in this Guaranty. SECTION 1.2 Certain Defined Terms. As used in this Guaranty, the following terms shall have the following meanings: "Guaranteed Obligations" is defined in Section 2.1. "Guaranty Taxes" is defined in Section 3.8(a). "Holder" means, in respect of any Guaranteed Obligation, the Person entitled to enforce payment thereof and specifically includes the Lender. "Permitted Payment" means the payment when due, but not earlier, of any amount permitted to be paid under Section 6.8K of the Financing Agreement, but only if, at the time such payment is made, no Default or Event of Default has occurred and is Continuing. "Subordinated Liabilities" is defined in Section 2.8(a). SECTION 1.3 Section References. References herein to a "Section," when not further identified by reference to any law or agreement, are references to the Sections of this Guaranty. 2 3 EXECUTION COPY ARTICLE II GUARANTY AND RELATED PROVISIONS SECTION 2.1 Guaranty. Each Guarantor hereby absolutely and unconditionally guarantees the punctual payment when due, whether at stated maturity, by acceleration or otherwise, of (i) all Obligations now outstanding or hereafter arising under or in connection with the Financing Agreement or any other Loan Document, whether for principal, interest, reimbursement for payments made under Letters of Credit or a Letter of Credit Guaranty, fees, taxes, additional compensation, expense reimbursements, indemnification or otherwise, and (ii) all liabilities of each other Guarantor now outstanding or hereafter arising under the Financing Agreement or this Guaranty, and (iii) each other debt, liability or obligation of the Borrower or any Guarantor now outstanding or hereafter arising under any of the Loan Documents (such Obligations, liabilities and other debts, liabilities and obligations, collectively, are the "Guaranteed Obligations"). SECTION 2.2 Acceleration of Payment. If the Obligations become immediately due and payable pursuant to Section 9.3 of the Financing Agreement, then all liability of each Guarantor under this Guaranty in respect of any Guaranteed Obligation that is not then due and payable shall thereupon become and be immediately due and payable, without notice or demand. SECTION 2.3 Guaranty Absolute and Unconditional. Each Guarantor guarantees that the Guaranteed Obligations will be paid in accordance with the terms of the Financing Agreement and the other Loan Documents, regardless of any law, regulation or order now or hereafter in effect in any jurisdiction affecting any of such terms or the rights and claims of any Holder of Guaranteed Obligations against the Borrower or any other Guarantor with respect thereto and even if any such rights or claims are modified, reduced or discharged in the Cases or otherwise. The obligations of each Guarantor under this Guaranty are independent of the Guaranteed Obligations, and a separate action or actions may be brought and prosecuted against each Guarantor to enforce this Guaranty, whether or not any action is brought against the Borrower or any other Guarantor and whether or not the Borrower or any other Guarantor is joined in any such action or actions. The liability of each Guarantor under this Guaranty shall be absolute and unconditional irrespective of, and shall not be affected or impaired in any manner by, (i) any lack of validity or enforceability of the Financing Agreement or any other Loan Document or any other agreement or instrument relating thereto; (ii) any change in the time, manner or place of payment of, or in any other term of, any of the Guaranteed Obligations, or any other amendment or waiver of or any consent to departure from the Financing Agreement or 3 4 EXECUTION COPY any other Loan Document, including, without limitation, any increase in the Guaranteed Obligations resulting from the extension of additional credit to the Borrower or any of its Subsidiaries or otherwise; (iii) any taking, exchange, release or non-perfection of any Lien securing, or any taking, release or amendment or waiver of or consent to departure from any other guaranty of, any of the Guaranteed Obligations; (iv) any manner or order of sale or other enforcement of any Lien securing any or all of the Guaranteed Obligations or any manner or order of application of the proceeds of any such Lien to the payment of the Guaranteed Obligations or any failure to enforce any Lien or to apply any proceeds thereof; (v) any change, restructuring or termination of the corporate structure or existence of the Borrower or any of its Subsidiaries, any Guarantor, or any other Person; or (vi) any other circumstance which might otherwise constitute a defense (except the defense of payment) available to, or a discharge of, a surety or guarantor. SECTION 2.4 Guaranty Irrevocable and Continuing. This Guaranty is an irrevocable and continuing offer and agreement guaranteeing payment of any and all Guaranteed Obligations and shall extend to all Guaranteed Obligations now outstanding or created or incurred at any future time, whether or not created or incurred pursuant to any agreement presently in effect or hereafter made, until all obligations of the Lender to extend credit to the Borrower pursuant to the Financing Agreement have expired or been terminated, all Letters of Credit have been discharged, and all Guaranteed Obligations have been fully, finally and indefeasibly paid. To the extent any contingent Obligation survives the expiration or termination of the Financing Agreement and the repayment of the Obligations that are then due, each Guarantor's liability under this Guaranty shall likewise survive. This Guaranty may be released only in writing. SECTION 2.5 Reinstatement. If at any time any payment on any Guaranteed Obligation is set aside, avoided or rescinded or must otherwise be restored or returned, this Guaranty and the liability of each Guarantor under this Guaranty shall remain in full force and effect and, if previously released or terminated, shall be automatically and fully reinstated, without any necessity for any act, consent or agreement of any Guarantor, as fully as if such payment had never been made and as fully as if any such release or termination had never become effective. SECTION 2.6 Waiver. Each Guarantor hereby waives and agrees not to assert or take advantage of: (a) Marshaling. Any right to require any Holder of Guaranteed Obligations to proceed against or exhaust its recourse against the Borrower, any other Guarantor or any other Person liable for any of the Guaranteed 4 5 EXECUTION COPY Obligations or against any Lien securing any of the Guaranteed Obligations or against any other Person or property, before demanding and enforcing payment of the Guaranteed Obligations from any Guarantor under this Guaranty; (b) Other Defenses. Any defense that may arise by reason of (i) the incapacity, lack of authority, death or disability of the Borrower, any other Guarantor or any other Person; (ii) the revocation or repudiation of any of the Loan Documents by the Borrower, any other Guarantor or any other Person; (iii) the unenforceability in whole or in part of the Loan Documents or any other instrument, document or agreement; (iv) the failure of any Holder of Guaranteed Obligations to file or enforce a claim against any Person liable for any of the Guaranteed Obligations or in any of the Cases or any other insolvency or liquidation proceeding; (v) any election made by any Holder of Guaranteed Obligations as to any right or remedy granted or available to it under the Bankruptcy Code; or (vi) any other borrowing or grant of a security interest under Section 364 of the Bankruptcy Code; (c) Notices. Presentment, demand for payment, protest, notice of discharge, notice of acceptance of this Guaranty, notice of the incurrence of, or any default in respect of, any Guaranteed Obligation, and all other indulgences and notices of every type or nature, including, without limitation and to the maximum extent permitted by law, notice of the disposition of any collateral for any of the Guaranteed Obligations; (d) Election of Remedies. Any defense based upon an election of remedies (including, if available, an election to proceed by non-judicial foreclosure) or any other act or omission of any Holder of Guaranteed Obligations or any other Person which destroys or otherwise impairs any right that any Guarantor might otherwise have for subrogation, recourse, reimbursement, indemnity, exoneration, contribution or otherwise against the Borrower, any other Guarantor or any other Person; (e) Collateral. Any defense based upon any grant of, any failure to demand, take, perfect, protect or enforce, or any modification or release of any Lien securing, or guaranty of, any or all of the Guaranteed Obligations, or any failure to create or perfect or ensure the priority or enforceability of any security interest in any collateral for any of the Guaranteed Obligations or any act or omission related thereto; (f) Offsets. Any right to recoup from or offset against any of the Guaranteed Obligations any claim that may be held or asserted by or available 5 6 EXECUTION COPY to (i) the Borrower or any other Guarantor or any other Person liable for any of the Guaranteed Obligations against any Holder of Guaranteed Obligations or (ii) any Guarantor against the Borrower, any other Guarantor, any other Holder of Guaranteed Obligations or any other Person; or (g) Defenses of Others. Any other claim, right or defense (including, by way of illustration and without limitation, such matters as failure or insufficiency of consideration, statute of limitations, breach of contract, tortious conduct, accord and satisfaction, and discharge by agreement or conduct or in any of the Cases or any other insolvency or liquidation proceeding), except the defense of payment, that may be held or asserted by or available to (i) the Borrower or any other Guarantor or any other Person liable for any of the Guaranteed Obligations against any Holder of Guaranteed Obligations or (ii) any Guarantor against the Borrower, any other Guarantor, any other Holder of Guaranteed Obligations or any other Person. SECTION 2.7 Subrogation. Each Guarantor hereby represents, warrants and agrees, in respect of any and all present and future rights of subrogation, recourse, reimbursement, indemnity, exoneration, contribution and other claims that such Guarantor at any time may have against the Borrower, any other Guarantor or any other Person liable for the payment of any of the Guaranteed Obligations (including, without limitation, the owner of any interest in collateral subject to a Lien securing any of the Guaranteed Obligations) as a result of or in connection with this Guaranty or any payment hereunder, that: (a) No Agreement. Such Guarantor has not entered into, and agrees that it will not enter into, any agreement providing, directly or indirectly, for any such right or claim against the Borrower or, except as set forth in Section 2.10, against any other Guarantor or any Subsidiary of the Borrower and each such agreement now existing or hereafter entered into (except Section 2.10) is and shall be void; (b) Release. Such Guarantor waives and releases any such right or claim against the Borrower, any other Guarantor or any other such Person until the Guaranteed Obligations have been paid in full; (c) No Claim Created Hereby. Neither the execution and delivery of this Guaranty by such Guarantor nor any payment by such Guarantor under this Guaranty shall give rise to any claim (as that term is defined in the Bankruptcy Code) in favor of such Guarantor against the Borrower until the Guaranteed Obligations have been paid in full; and 6 7 EXECUTION COPY (d) Subordination of Contribution Rights. Such Guarantor reserves, as against each other Guarantor, its right of contribution under Section 2.10 but agrees that all such contribution rights shall be included among the Subordinated Liabilities. SECTION 2.8 Subordination Provisions. (a) Subordination. Any and all present and future debts, liabilities and obligations of every type and description (whether for money borrowed, on intercompany accounts, for provision of goods or services, under tax sharing or contribution agreements or on account of any other transaction, agreement, occurrence or event and whether absolute or contingent, direct or indirect, matured or unmatured, liquidated or unliquidated, created directly or acquired from another, or sole, joint, several or joint and several) now outstanding or hereafter incurred, arising or owed to any Guarantor by the Borrower or any Subsidiary of the Borrower or by any other Guarantor (the "Subordinated Liabilities") shall be, and hereby are, subordinated to full and final payment of the Guaranteed Obligations. (b) Prohibited Payments. Until the Termination Date and at all times thereafter until all outstanding Guaranteed Obligations (except indemnification obligations if no claim has been made) have been paid in full and discharged, no Guarantor will demand, sue for, accept or receive, or cause or permit any other Person to make, any payment on or transfer of property on account of any Subordinated Liabilities, except a Permitted Payment. (c) No Liens or Transfers. Each Guarantor agrees that (i) it will not demand, accept or hold any Lien upon any real or personal property of the Borrower or any of its Subsidiaries as security for any of the Subordinated Liabilities and (ii) any such Lien shall be void. (d) Priority of Payment; Turnover. In each of the Cases and in each other insolvency or liquidation proceeding by, against or affecting the Borrower or any of its Subsidiaries or any Guarantor, the Holders of Guaranteed Obligations shall be entitled to receive payment in full of all amounts due or to become due on or in respect of the Guaranteed Obligations, or provision shall be made for such payment in money or money's worth, before any Guarantor is entitled to receive any payment or distribution of any kind or character, whether in cash, property or securities, on account of any of the Subordinated Liabilities, except a Permitted Payment; and to that end the Holders of Guaranteed Obligations shall be entitled to receive, for application to the 7 8 EXECUTION COPY payment thereof, all payments and distributions of any kind or character (except a Permitted Payment), whether in cash, property or securities (including any such payment or distribution which may be payable or deliverable by reason of the payment of any other debt or liability of the Borrower or any Subsidiary of the Borrower or any Guarantor being subordinated to the payment of the Subordinated Liabilities), which may be payable or deliverable in respect of the Subordinated Liabilities in any of the Cases or in any such insolvency or liquidation proceeding. (e) Held in Trust. If any payment, transfer or distribution is made to any Guarantor upon any Subordinated Liabilities that is not permitted to be made under this Section 2.8 or that the Holders of Guaranteed Obligations are entitled to receive under this Section 2.8, such Guarantor shall receive and hold the same in trust, as trustee for the benefit of the Holders of Guaranteed Obligations, and shall forthwith transfer and deliver the same to the Lender, in precisely the form received (except for any required endorsement), for application to the payment of Guaranteed Obligations. (f) Claims in Bankruptcy. Each Guarantor will file all claims against the Borrower or any Subsidiary of the Borrower or any Guarantor in the Cases and in each other insolvency or liquidation proceeding in which the filing of claims is required or permitted by law upon any of the Subordinated Liabilities and will assign to the Lender, for the benefit of the Holders of Guaranteed Obligations, all rights of such Guarantor thereunder. If any Guarantor does not file any such claim at least 30 days prior to any applicable claims bar date, the Lender is hereby authorized (but shall not be obligated), as attorney-in-fact for such Guarantor with full power of substitution, either to file such claim or proof thereof in the name of such Guarantor or, at the option of the Lender, to assign the claim and cause the claim or proof thereof to be filed by an agent or nominee. The Lender and its agents and nominees shall have the sole right, but no obligation, to accept or reject any plan proposed in any of the Cases or any other insolvency or liquidation proceeding and to cast any votes and to take any other action with respect to all claims upon any of the Subordinated Liabilities. (g) Subordination Effective and not Impaired. This Section 2.8 shall remain effective for so long as this Guaranty is continuing and thereafter for so long as any Guaranteed Obligation is outstanding. Each Guarantor's obligations under this Section 2.8 (i) shall be absolute and unconditional as set forth in Section 2.3, irrevocable and continuing as set forth in Section 2.4, subject to reinstatement as set forth in Section 2.5 and not be affected or impaired by any of the matters waived in Section 2.6; (ii) shall be subject to the provisions of 8 9 EXECUTION COPY Article III; and (iii) shall otherwise be as equally enduring and free from defenses as such Guarantor's liability under this Guaranty. SECTION 2.9 No Fraudulent Transfer Limitation. Each Guarantor represents, warrants and agrees that its liability hereunder is undertaken by it as debtor and debtor in possession in a Case, upon approval of the Bankruptcy Court, and that, accordingly, enforcement of this Guaranty against any Guarantor for the full amount of the Guaranteed Obligations shall not in any manner be limited, restricted or impaired, and avoidance or recovery of any payment made by any Guarantor hereunder shall never be permitted, under any applicable fraudulent conveyance or fraudulent transfer law or any comparable law. SECTION 2.10 Contribution among Guarantors. The Guarantors desire to allocate among themselves, in a fair and equitable manner, their rights of contribution from each other when any payment is made by one of the Guarantors under this Guaranty. Accordingly, if any payment is made by a Guarantor under this Guaranty (a "Funding Guarantor") that exceeds its Fair Share, the Funding Guarantor shall be entitled to a contribution from each other Guarantor in the amount of such other Guarantor's Fair Share Shortfall, so that all such contributions shall cause each Guarantor's Aggregate Payments to equal its Fair Share. For these purposes: (a) "Fair Share" means, with respect to a Guarantor as of any date of determination, an amount equal to (i) the ratio of (x) the Adjusted Maximum Amount of such Guarantor to (y) the aggregate Adjusted Maximum Amounts of all Guarantors, multiplied by (ii) the aggregate amount paid on or before such date by all Funding Guarantors under this Guaranty. (b) "Fair Share Shortfall" means, with respect to a Guarantor as of any date of determination, the excess, if any, of the Fair Share of such Guarantor over the Aggregate Payments of such Guarantor. (c) "Adjusted Maximum Amount" means, with respect to a Guarantor as of any date of determination, the maximum aggregate amount of the liability of such Guarantor under this Guaranty, limited to the extent required under Sections 2.9 and 2.11 (except that, for purposes solely of this calculation, any assets or liabilities arising by virtue of any rights to or obligations of contribution under this Section 2.10 shall not be counted as assets or liabilities of such Guarantor). (d) "Aggregate Payments" means, with respect to a Guarantor as of any date of determination, the aggregate net amount of all payments made on or 9 10 EXECUTION COPY before such date by such Guarantor under this Guaranty (including, without limitation, under this Section 2.10). The amounts payable as contributions hereunder shall be determined by the Funding Guarantor as of the date on which the related payment or distribution is made by the Funding Guarantor, and such determination shall be binding on the other Guarantors absent manifest error. The allocation and right of contribution among the Guarantors set forth in this Section 2.10 shall not be construed to limit in any way the liability of any Guarantor under this Guaranty to the Holders of the Guaranteed Obligations. SECTION 2.11 No Limitation of Liability. The liability of each Guarantor under this Guaranty shall be unlimited in amount. SECTION 2.12 Joint and Several Obligation. This Guaranty and all liabilities of each Guarantor hereunder shall be the joint and several obligation of each Guarantor and may be freely enforced against each Guarantor, for the full amount of the Guaranteed Obligations, without regard to whether enforcement is sought or available against any other Guarantor. SECTION 2.13 Super-Priority Status. Each Guarantor hereby agrees, represents and warrants that (i) pursuant to the authority granted under Section 364(c)(1) of the Bankruptcy Code and the applicable Approval Order, the liability of such Guarantor hereunder, as to all of the Guaranteed Obligations, shall constitutes an allowed administrative expense in such Guarantor's Case, with the same Super-Priority Status as that applicable to the Obligations, and (ii) any and all Second Tier Superpriority Claims granted to Wells Fargo pursuant to the Wells Fargo Stipulation and Order are in all respects subject and subordinate to such liability. Each Guarantor further agrees that (i) its liability hereunder, as to all of the Guaranteed Obligations, shall not be discharged by the entry of any Confirmation Order (and such Guarantor, pursuant to Section 1141(d)(4) of the Bankruptcy Code, hereby waives any such discharge) and (ii) the Super-Priority Status conferred upon the Holders of the Guaranteed Obligations pursuant to the Approval Orders shall not be affected in any manner by the entry of any Confirmation Order. ARTICLE III MISCELLANEOUS PROVISIONS SECTION 3.1 Condition of the Borrower. Each Guarantor is fully aware of the financial condition of the Borrower and its Subsidiaries and is executing 10 11 EXECUTION COPY and delivering this Guaranty based solely upon such Guarantor's own independent investigation of all matters pertinent hereto and is not relying in any manner upon any representation or statement by any Holder of Guaranteed Obligations. Each Guarantor represents and warrants that it is in a position to obtain, and each Guarantor hereby assumes full responsibility for obtaining, any additional information concerning the financial condition of the Borrower and each of its Subsidiaries and any other matter pertinent hereto as such Guarantor may desire, and such Guarantor is not relying upon or expecting any Holder of Guaranteed Obligations to furnish to such Guarantor any information now or hereafter in the possession of any Holder of Guaranteed Obligations concerning the same or any other matter. By executing this Guaranty, each Guarantor knowingly accepts the full range of risks encompassed within a contract of this type, which risks each Guarantor acknowledges. No Guarantor shall have the right to require any Holder of Guaranteed Obligations to obtain or disclose any information with respect to the Guaranteed Obligations, the financial condition or prospects of the Borrower or any Subsidiary of the Borrower, the ability of the Borrower or any Subsidiary of the Borrower to pay or perform the Guaranteed Obligations, the existence, perfection, priority or enforceability of any collateral security for any or all of the Guaranteed Obligations, the existence or enforceability of any other guaranties of all or any part of the Guaranteed Obligations, any action or non-action on the part of any Holder of Guaranteed Obligations, the Borrower, any Subsidiary of the Borrower or any other Person, or any other event, occurrence, condition or circumstance whatsoever. SECTION 3.2 Amendments. (a) Amendment to Guaranty. No amendment or waiver of any provision of this Guaranty, no consent to any departure by any Guarantor herefrom, shall in any event be effective unless the same shall be in writing and signed by the Lender, and then such waiver or consent shall be effective only in the specific instance and for the specific purpose for which given. (b) Amendment or Modification of Other Loan Documents. The other Loan Documents may be amended, modified or supplemented in accordance with their respective terms without notice to or consent or agreement by any Guarantor, including, without limitation, so as to (i) alter, compromise, modify, accelerate, extend, renew, refinance or change the time or manner for making of loans or advances, provision of other financial accommodations, or the payment or performance of all or any portion of the Guaranteed Obligations, (ii) increase or reduce the rate of interest or amount of principal payable on the Guaranteed Obligations or other Obligations, (iii) release or discharge the Borrower, any other Guarantor or any other Person as 11 12 EXECUTION COPY to all or any portion of the Guaranteed Obligations, or (iv) release, substitute or add any one or more guarantors or endorsers, accept additional or substituted security for payment or performance of the Guaranteed Obligations, or release or subordinate any security therefor. SECTION 3.3 Notices. All notices and other communications provided for hereunder shall be in writing and sufficient if given in accordance with Section 11.8 of the Financing Agreement. SECTION 3.4 Right of Set-off. If the Lender terminates its commitment or accelerates the Obligations pursuant to Section 9.3 of the Financing Agreement, the Lender and each of its participants (if any), successors and assigns shall have the right at any time and from time to time thereafter, to the fullest extent permitted by law, to set off and apply any and all deposits (general or special, time or demand, provisional or final) at any time held and other liability at any time owing by the Lender or any of its participants, successors and assigns to or for the credit or the account of any Guarantor against any and all liability of such Guarantor under this Guaranty, whether or not any demand for payment has then been made or notice has then been given under this Guaranty and even though such deposit or liability may then be unmatured. The Lender agrees promptly to notify the affected Guarantor after any such set-off and application made by the Lender, but the failure to give such notice shall not affect the validity of such set-off and application. The rights of the Lender and its participants (if any), successors and assigns under this Section 3.4 are in addition to all other rights and remedies (including, without limitation, other rights of set-off) granted or available to any of them. SECTION 3.5 Successors and Assigns. This Guaranty is binding upon and enforceable against each Guarantor, its successors and assigns, and shall inure to the benefit of, and be enforceable by, each Holder of any of the Guaranteed Obligations and such Holder's heirs, representatives, successors and assigns. SECTION 3.6 No Inquiry. Each Holder of Guaranteed Obligations may rely, without further inquiry, on the power and authority of each Guarantor, the Borrower and each of its Subsidiaries and on the authority of all officers, directors and agents acting or purporting to act on their behalf. SECTION 3.7 Certain Waivers. If, in the exercise of any rights and remedies, any Holder of Guaranteed Obligations shall forfeit any of its rights or remedies, including its right to enter a deficiency judgment against the Borrower or any other Guarantor or any other Person, whether because of any applicable laws pertaining to "election of remedies" or the like, each Guarantor hereby consents to 12 13 EXECUTION COPY such action by such Holder and, to the maximum extent permitted by applicable law, waives any claim or defense (including any defense based upon the election of remedies under the provisions of Section 580d of the California Code of Civil Procedure) based upon such election of remedies, even if such action by such Holder shall result in a full or partial loss of any rights of subrogation, contribution or indemnification, and/or any right of Guarantor to proceed against any Person for reimbursement, which Guarantor might otherwise have had but for such action by such Holder or the terms herein. Furthermore, each Guarantor waives all rights and defenses arising out of an election of remedies by any Holder of Guaranteed Obligations, even though that election of remedies, such as a nonjudicial foreclosure with respect to security for a Guaranteed Obligation, has destroyed such Guarantor's rights of subrogation and reimbursement against the Borrower or any other Guarantor or any other Person by the operation of Section 580d of the California Code of Civil Procedure or otherwise. Any election of remedies which results in the denial or impairment of the right of any Holder of Guaranteed Obligations to seek a deficiency judgment against the Borrower or any Guarantor shall not, to the maximum extent permitted by applicable law, impair any other Guarantor's obligation to pay the full amount of the Guaranteed Obligations. In the event any Holder of Guaranteed Obligations shall bid at any foreclosure or trustee's sale or at any private sale permitted by law or the Loan Documents, such Holder may bid all or less than the amount of the Guaranteed Obligations and the amount of such bid need not be paid by such Holder but shall be credited against the Guarantied Obligations. To the extent permitted by applicable law, the amount of the successful bid at any such sale, whether any Holder of Guaranteed Obligations or any other Person is the successful bidder, shall be conclusively deemed to be the fair market value of the property being sold and the difference between such bid amount and the remaining balance of the Guaranteed Obligations shall be conclusively deemed to be the amount of the Guaranteed Obligations guarantied under this Guaranty, notwithstanding that any present or future law or court decision or ruling may have the effect of reducing the amount of any deficiency claim to which any Holder of Guaranteed Obligations might otherwise be entitled if no Holder had bid at any such sale. Each Guarantor hereby expressly waives any and all benefits which might otherwise be available to it under California Civil Code Sections 2809, 2810, 2819, 2820, 2821, 2822, 2839, 2845, 2848, 2849, 2850, 2899 and 3433 and California Code of Civil Procedure Sections 580a, 580b, 580d and 726. The foregoing waivers are included solely out of an abundance of caution and shall not be construed to mean that any of the referenced provisions of California law are in any way applicable to this Guaranty or to any of the Guaranteed Obligations. SECTION 3.8 Payments Free and Clear of Taxes. 13 14 EXECUTION COPY (a) Payment. Each Guarantor agrees to pay any and all present or future taxes, levies, imposts, deductions, charges or withholdings, and all liabilities with respect thereto which arise from any payment made hereunder or from the execution, delivery or registration of, or otherwise with respect to, this Guaranty, excluding, with respect to any Holder of Guaranteed Obligations, taxes imposed on its net income (collectively, the "Guaranty Taxes"). (b) Indemnity. Each Guarantor hereby indemnifies each Holder of Guaranteed Obligations for the full amount of Guaranty Taxes (including, without limitation, any Guaranty Taxes imposed by any jurisdiction on amounts payable under this Section 3.8) paid by such Holder and any liability (including penalties, interest and expenses) arising therefrom or with respect thereto (plus interest on any amounts not paid within thirty days from the date written demand is made therefor at the Default Rate of Interest that would then be applicable under the Financing Agreement to any defaulted Revolving Loans, whether or not any Revolving Loans are then outstanding or in default), whether or not such Guaranty Taxes were correctly or legally asserted; provided, however, that if any such Holder subsequently recoups all or any part of such amount from the relevant taxation authority or other authority, then such Holder shall identify and remit the amount of the recoupment to such Guarantor within five Business Days after it receives the recoupment. (c) Survival. Without prejudice to the survival of any other agreement of any Guarantor hereunder, the agreements and obligations of each Guarantor contained in this Section 3.8 shall survive the full and final payment and performance of the Guaranteed Obligations. (d) Receipt. Within 30 days after the date of any payment of Guaranty Taxes by any Guarantor, such Guarantor shall furnish to the Lender a receipt for any Guaranty Taxes paid by such Guarantor pursuant to this Section 3.8. SECTION 3.9 No Waiver; Remedies. No failure on the part of any Holder of Guaranteed Obligations to exercise, and no delay in exercising, any right hereunder shall operate as a waiver thereof, and no single or partial exercise of any right hereunder shall preclude any other or further exercise of any other right or of the same right as to any other matter or on a subsequent occasion. SECTION 3.10 Remedies Cumulative. All rights, powers and remedies of each Holder of Guaranteed Obligations under this Guaranty, under any other agreement now or at any time hereafter in effect between any such Holder and any 14 15 EXECUTION COPY Guarantor (whether relating to the Guaranteed Obligations or otherwise) or now or hereafter existing at law or in equity or by statute or otherwise, shall be cumulative and concurrent and not alternative and each such right, power and remedy may be exercised independently of, and in addition to, each other such right, power or remedy. SECTION 3.11 Severally Enforceable. This Guaranty may be enforced severally and successively by any one or more of the Holders of Guaranteed Obligations in one or more actions, whether independent, concurrent, joint, successive or otherwise. The claims, rights and remedies of any Holder of Guaranteed Obligations (i) may not be modified or waived by any other Holder and (ii) shall not be reduced, discharged, affected or impaired by any deed, act or omission, whether or not wrongful, of any other Holder. SECTION 3.12 Counterparts. This Guaranty may be executed in counterparts, and each such counterpart for all purposes shall be deemed an original and all such counterparts together shall constitute but one and the same agreement. SECTION 3.13 Severability. If any provision hereof or the application thereof in any particular circumstance is held to be unlawful or unenforceable in any respect, all other provisions hereof and such provision in all other applications shall nevertheless remain effective and enforceable to the maximum extent lawful. SECTION 3.14 Integration. This Guaranty and the other Loan Documents to which any Guarantor is party are intended as an integrated and final expression of the entire agreement of such Guarantor with respect to the subject matter hereof and thereof. No representation, understanding, promise or condition concerning the subject matter hereof and thereof shall be binding upon any Holder of Guaranteed Obligations unless expressed herein or therein, and no course of prior dealing or usage of trade, and no parol or extrinsic evidence of any nature, shall be admissible to supplement, modify or vary any of the terms hereof or thereof. Acceptance of or acquiescence in a course of performance rendered under this Guaranty or any other dealings between any Guarantor and any Holder of Guaranteed Obligations shall not be relevant to determine the meaning of this Guaranty even though the accepting or acquiescing party had knowledge of the nature of the performance and opportunity for objection. SECTION 3.15 GOVERNING LAW; SUBMISSION TO JURISDICTION; WAIVER OF JURY TRIAL; WAIVER OF DAMAGES. 15 16 EXECUTION COPY (a) GOVERNING LAW. THIS GUARANTY SHALL BE GOVERNED BY, AND CONSTRUED IN ACCORDANCE WITH, THE LAWS OF THE STATE OF CALIFORNIA, SUBJECT TO APPLICABLE PROVISIONS OF THE BANKRUPTCY CODE. (b) SUBMISSION TO JURISDICTION. EACH GUARANTOR HEREBY IRREVOCABLY WAIVES PERSONAL SERVICE OF PROCESS AND CONSENTS TO SERVICE OF PROCESS BY CERTIFIED OR REGISTERED MAIL, RETURN RECEIPT REQUESTED. ANY JUDICIAL PROCEEDING BROUGHT BY OR AGAINST ANY GUARANTOR WITH RESPECT TO ANY OF THE GUARANTEED OBLIGATIONS, THIS GUARANTY OR ANY RELATED AGREEMENT MAY BE BROUGHT IN ANY COURT OF COMPETENT JURISDICTION IN THE STATE OF CALIFORNIA, UNITED STATES OF AMERICA, AND, BY EXECUTION AND DELIVERY OF THIS GUARANTY, EACH GUARANTOR ACCEPTS FOR ITSELF AND IN CONNECTION WITH ITS PROPERTIES, GENERALLY AND UNCONDITIONALLY, THE NON-EXCLUSIVE JURISDICTION OF THE AFORESAID COURTS AND IRREVOCABLY AGREES TO BE BOUND BY ANY FINAL, NON-APPEALABLE JUDGMENT RENDERED THEREBY. THE BORROWER AND EACH GUARANTOR WAIVES ANY OBJECTION TO JURISDICTION AND VENUE OF ANY ACTION INSTITUTED HEREUNDER AND SHALL NOT ASSERT ANY DEFENSE BASED ON LACK OF JURISDICTION OF VENUE OR BASED UPON FORUM NON CONVENIENS. NOTHING HEREIN SHALL AFFECT THE RIGHT TO SERVE PROCESS IN ANY MANNER PERMITTED BY LAW OR SHALL LIMIT THE RIGHT OF ANY HOLDER OF GUARANTEED OBLIGATIONS TO BRING PROCEEDINGS AGAINST ANY GUARANTOR IN THE COURTS OF ANY OTHER JURISDICTION. (c) WAIVER OF JURY TRIAL. TO THE FULLEST EXTENT PERMITTED BY LAW, EACH GUARANTOR AND HOLDER OF GUARANTEED OBLIGATIONS HEREBY WAIVES ANY RIGHT TO A TRIAL BY JURY IN ANY ACTION OR PROCEEDING ARISING OUT OF THIS FINANCING AGREEMENT. (d) LIMITATION OF LIABILITY. NO CLAIM MAY BE MADE BY ANY GUARANTOR AGAINST THE LENDER OR ANY OF THE LENDER'S AFFILIATES, DIRECTORS, OFFICERS, EMPLOYEES, ATTORNEYS OR AGENTS FOR ANY SPECIAL, INDIRECT, CONSEQUENTIAL OR PUNITIVE DAMAGES IN RESPECT OF ANY 16 17 EXECUTION COPY CLAIM (WHETHER BASED UPON ANY BREACH OF CONTRACT, TORT, BREACH OF STATUTORY DUTY OR ANY OTHER THEORY OF LIABILITY) ARISING OUT OF OR RELATED TO THE TRANSACTIONS CONTEMPLATED BY THE FINANCING AGREEMENT, THIS GUARANTY OR ANY OTHER LOAN DOCUMENT, OR ANY ACT, OMISSION OR EVENT OCCURRING IN CONNECTION THEREWITH, AND EACH GUARANTOR HEREBY WAIVES, RELEASES AND AGREES NOT TO SUE UPON ANY CLAIM FOR ANY SUCH DAMAGES, WHETHER OR NOT NOW ACCRUED AND WHETHER OR NOT KNOWN OR SUSPECTED TO EXIST IN ITS FAVOR. SECTION 3.16 Acceptance and Notice. Each Guarantor acknowledges acceptance hereof and reliance hereon by each Holder of any of the Guaranteed Obligations and waives, irrevocably and forever, all notice thereof. 18 EXECUTION COPY IN WITNESS WHEREOF, each Guarantor has caused this Guaranty to be duly executed and delivered by its officer thereunto duly authorized as of the date first above written. THE CLOTHESTIME, INC., as Debtor and Debtor in Possession By /s/ David A. Sejpal -------------------------------- Title: Vice President, Chief Financial Officer, Treasurer and Secretary MRJ INDUSTRIES, INC., as Debtor and Debtor in Possession By /s/ David A. Sejpal -------------------------------- Title: Vice President, Chief Financial Officer, Treasurer and Assistant Secretary CLOTHESTIME INVESTMENT, INC., as Debtor and Debtor in Possession By /s/ David A. Sejpal -------------------------------- Title: President and Secretary CLOTHESTIME INTERNATIONAL, INC., as Debtor and Debtor in Possession By /s/ David A. Sejpal -------------------------------- Title: Special Agent CLOTHESTIME ACQUISITION CORPORATION, as Debtor and Debtor in Possession By /s/ David A. Sejpal -------------------------------- Title: Vice President, Chief Financial Officer, Treasurer and Assistant Secretary S-1 EX-21 7 SUBSIDIARIES OF CLOTHESTIME, INC 1 EXHIBIT 21 SUBSIDIARIES OF THE CLOTHESTIME, INC. Name State of Incorporation ---- ---------------------- 1. MRJ Industries, Inc. Delaware 2. Clothestime Acquisition Corporation Delaware 3. Clothestime Insurance Company Vermont 4. Clothestime International, Inc. Delaware 5. Clothestime Investment, Inc. Delaware 6. Clothestime Stores, Inc. Delaware EX-23 8 INDEPENDENT AUDITORS' CONSENT 1 EXHIBIT 23 INDEPENDENT AUDITORS' CONSENT The Board of Directors The Clothestime, Inc.: We consent to incorporation by reference in the registration statements (Nos. 2-90248, 2-92111, 33-3304, 33-24130, 33-31971, 33-34972, 33-43530, 33-43531, 33-69656 and 33-81432) on Form S-8 of The Clothestime, Inc. of our report dated April 4, 1996, relating to the consolidated balance sheets of The Clothestime, Inc. and subsidiaries as of January 27, 1996 and January 28, 1995, and the related consolidated statements of operations, shareholders' equity and cash flows for each of the years in the three-year period ended January 27, 1996, which report appears in the January 27, 1996 annual report on Form 10-K of The Clothestime, Inc. The consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note A to the consolidated financial statements, The Clothestime, Inc. and certain of its subsidiaries (collectively, the "Debtors") commenced reorganization cases by filing voluntary petitions for relief under chapter 11 of the United States Bankruptcy Code in the United States Bankruptcy Court for the Central District of California (the "Bankruptcy Court") on December 8, 1995. The Debtors are currently operating their respective businesses as debtors-in-possession under the jurisdiction of the Bankruptcy Court and continuation of The Clothestime, Inc. and its subsidiaries as a going concern is contingent upon, among other things, the ability to (1) formulate an acceptable plan of reorganization that will be confirmed by the Bankruptcy Court, (2) achieve satisfactory levels of profitable operations and (3) maintain compliance with the debtor-in-possession financing and generate adequate sources of other liquidity, as described in Note A to the consolidated financial statements. These contingencies and the uncertainties inherent in the bankruptcy process raise substantial doubt about the ability of The Clothestime, Inc. and its subsidiaries to continue as a going concern. The consolidated financial statements do not include any adjustments that might result from the outcome of these uncertainties. KPMG PEAT MARWICK LLP Orange County, California April 26, 1996 EX-27 9 FINANCIAL DATA SCHEDULE
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM (A) THE CONSOLIDATED BALANCE SHEETS AND THE CONSOLIDATED STATEMENTS OF OPERATIONS AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH (B) FINANCIAL STATEMENTS. 1,000 12-MOS JAN-27-1996 JAN-29-1995 JAN-27-1996 34,478 3,192 0 0 8,551 58,736 55,282 27,384 88,280 26,064 0 0 0 15 8,296 88,280 308,231 308,809 236,872 236,872 0 0 769 (53,008) (10,006) (43,002) 0 0 0 (43,002) (3.03) (3.03)
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